Tax Loss Harvesting

Time for Tax Loss Harvesting

I know it’s time to start thinking about capital gains in our taxable accounts when I see Christmas trees covering our Costco warehouse floor.  This year, the plastic look alike’s were out even before Halloween.  Luckily, there is still plenty of time to minimize the tax effect of my capital gains with a tax loss harvesting strategy.

xmas tree

We are all about paying our fair share for taxes, but we like to minimize the burden by following the rules in place by our government.

Usually our portfolio has minimal turnover and this year is no different with less than 5% turnover.  However, we locked in some long-term gains by selling a few holdings, namely Bank of America and Norfolk Southern.  I also recently disclosed I sold two speculative call options for a nice gain.

So What… Why does this Matter?

These transactions resulted in over $10,000 in short-term gains and over $30,000 in long-term gains.  This will result in capital gains tax due in April.  In the US, the capital tax rate is progressive and is based on earned income. There are also different tax rates for short-term holdings versus long-term holdings. Long term is defined as an asset being held for over a year.

For lower earners, many long-term gains are a tax-free event.  For high earners, the taxman still wants a piece of your gain.

2017 Capital Gains Tax Rate

Capital Gains Rate

Tax Loss Harvesting Strategy

To minimize the tax burden of your stock sales, you can apply a strategy called tax loss harvesting.  This strategy calls for selling your duds for capital losses before the end of 2017 calendar year.  These losses can offset the gains made in the year.   For instance, if I have $10,000 in short-term gains, I can sell a position that has a $10,000 short-term loss and eliminate the tax associated with the gain.

Fortunately or unfortunately, there aren’t many positions in our portfolio that are negative due to the frothy stock market.   However, we can save about one-third of our capital gains tax bill by selling shares of one energy company.  We still need to pay commission on the trade but the tax savings far outweigh the expense.

What if you have multiple lots with varied cost basis with the loser stock?

I purchased shares of a large energy company over a seven-year period with varying cost basis on each lot.  Your brokerage likely allows you to specify which lots you are closing out.  To maximize the effectiveness of the tax loss harvesting, I picked the highest priced cost basis lots to close out.

Careful here, you only have a few days to specify which methodology to use after selling shares.  Our brokerage defaults the setting to First In – First Out (FIFO). Changing the FIFO setting to HIFO is also good way to minimize capital gains if you are only selling a portion of shares.  In my situation, I eliminated the full position so it didn’t matter.

Highest In – First Out (HIFO) – The lots with the highest adjusted cost basis will be closed out first and is not dependent on the length of time the shares have been held.  This option allows me to maximize my tax lost harvesting.

What if you only have capital losses and no capital gains?

Nobody is investing to lose money but it happens every now and then.  There is good news for you.  Let’s say you sold shares of one loser stock this year and it resulted in a $10,000 loss.  You also have no realized capital gains this year.  The IRS feels bad for you this year and allows you to deduct up to $3,000 from your ordinary income.  But wait there’s more!  Any additional losses can be carried over to the future.  Make sure to keep track because losses can be carried forward indefinitely.

Common Tax Loss Harvesting Mistake – Wash Sale

A wash sale is when you sell your loser stock and buy back the same security within 30 days.  If you do this, the original loss gets added to your new positions cost basis.  You can still claim the loss later, unless the security goes up in price over the new increased cost basis.

The same is true for index funds.  If you sell an index fund that tracks the S&P 500 you cannot go purchase a different index fund that tracks the same S&P 500.  The IRS would likely call that investment “substantially identical.”   If you want to redeploy the funds, make sure you pick an investment that is noticeably different from what you sold or wait the 30 days.


Have you looked at your portfolio to optimize the tax impact?  Do you use a tax loss harvesting strategy?


    1. Honestly I thought about holding it all in cash. I ended up redeploying half to a pipeline company I have been eyeing. The other half will likely get redeployed later back to the original investment.

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