Does Tax Loss Harvesting Matter?

Crestwood Advisors writes: The recent Memorial Day weekend kicked off the “unofficial” start of summer.  Contrary to the old adage “sell in May then go away” the team at Crestwood does not have a summer sabbatical planned for the next few months.

Through the summer we will continue to actively manage your accounts with the important goal of maximizing your net of fee and after tax returns.   As you may have noticed while filing your 2013 tax return, an important aspect of our ongoing portfolio management is tax loss harvesting in your taxable accounts.

Tax loss harvesting is defined as selling securities at a loss to offset a capital gains tax liability.  Capital losses generated can be used to offset other gains and reduce taxes.   Given a top Federal marginal tax rate on income of 39.6% and a top Federal tax rate on capital gains of 20%, or 23.8% for couples earning more that $250,000, these savings are increasingly important.

The opportunity that arises from reducing taxes and resulting in additional money in client accounts is significant and meaningful over time.  It becomes even more significant when the tax losses provide an opportunity to shift the recognition of gains into lower tax years. For example, you may be in a relatively lower tax bracket during early retirement years before you are subject to minimum distributions from your retirement portfolios.  In these years, depending upon your adjusted income, you may be able to reduce your tax rate on capital gains from 20% to 15% or potentially 0% and avoid the 3.8% Medicare Contribution tax.

Tax loss harvesting isn’t always as simple as it seems.  There are a number of important considerations that we need to pay attention to:

• Wash sales: if we sell a security or fund with losses and buy it back (or a substantially identical one) within 30 days before or after the sale, this is a wash sale.  Any losses generated can not be claimed for tax purposes.
• Death of taxpayer: capital losses cannot be carried over after a taxpayer’s death. These losses are deductible only on the final income tax return filed on the decedent’s behalf.
• Additional technical tax nuances with regards to short term capital losses on tax-exempt interest and qualified dividends, issues that are best left to your accountant.

As long term investors, each year we look to accrue benefits from tax loss harvesting.  Beyond offsetting gains, losses that exceed realized gains can be deducted against ordinary income up to $3,000 annually. These losses can then be carried forward indefinitely, first offsetting gains going forward and reducing your income annually until the loss is fully extinguished.

At Crestwood, our goal is to exceed client expectations. Our attention to the after-tax impact of investment decisions highlighted by our opportunistic and proactive approach to harvesting losses to reduce the taxes on your capital gains and/or ordinary income may provide a meaningful difference in your after-tax returns. Please let us know if you have any questions about how these considerations impact you. We are always eager to speak with you.