Finding a Balance Between Tax and Investment Decisions - Rodgers & Associates

Finding a Balance Between Tax and Investment Decisions

The strong stock market of 2013 could mean a tax hit for taxpayers holding securities in a taxable account. Tax loss harvesting is a popular year-end tax strategy to minimize gains. This strategy involves selling positions with unrealized losses to offset gains already realized. It can make sense from a tax perspective, especially for those subject to the new Medicare surtax or for when Social Security benefits become taxable, due to realized gains. However, before going through your portfolio harvesting losses, make sure the strategy makes sense from an investment perspective as well.

The tax benefit could come with investment risk that must be considered. One of the frequent mistakes can occur when an investor wants to sell a position to harvest the loss with the objective of buying back the same security. Tax laws require waiting 30 days before repur­chasing the same security. Failing to wait 30 days triggers the wash-sale rule, which disallows the loss for tax purposes. The investor sells the security, but the market rallies before the 30 days have passed. The investor can easily end up paying more to buy back the security than they will have saved in taxes.

Tax loss harvesting usually makes the most sense in the event of a very large loss or when the taxpayer is temporarily in a very high tax bracket. This strategy does not perma­nently avoid taxes. It defers them by lowering the cost basis on the investment position. Deferring the gain to a lower tax year could be beneficial. The strategy should ideally be used when the investor would want to sell the security anyway. Perhaps the position has been under­per­forming or doesn’t meet investment objec­tives anymore. The investor’s portfolio is reposi­tioned and tax benefits become a bonus.

The first priority should always be investment perfor­mance. Don’t let taxes get in the way of making smart investment decisions.