In the spirit of the Harvest Festival, let’s take a closer look at the concept of Tax-Loss Harvesting as it relates to the current tax environment and the uncertain future. We can begin with the foundation of the current tax environment: in general, the markets have rebounded since the 2008 financial collapse leaving many investors with more unrealized capital gains (appreciation) as each year passes. Net long term capital gains for tax year 2012 will be taxed at 15% and net short term capital gains are taxed at the taxpayer’s ordinary tax rate.
The idea of harvesting tax losses involves selling assets which have decreased in value, generating capital losses to off-set the tax liability from the taxable long term and short term capital gains otherwise already recognized. One constraint to this strategy is the net $3,000 capital loss limitation imposed, however taxpayers can carry forward capital losses to future years to off-set future capital gains when tax rates may be higher.
The preferential 15% tax rate of long term capital gains and even the ordinary tax rates are expected to increase in 2013 and beyond. Not to mention, whatever level Congress determines the future tax rates to be, investors may still incur the additional Medicare surtax (for more information see our other post ). This adds a monkey wrench in to the year-end tax planning.
Investors should at least consider an alternative approach: Tax-Gain Harvesting. This involves selling appreciated assets (assets which have increased in value), generating capital gains to ‘lock-in’ the lower tax rates available this year that may not be there in 2013. If there is still a desire to continue to hold the investment, an investor can re-purchase the stock, or similar stock, shortly after the sale because there are no wash-sale rules associated with gain recognition.* The result may be a tax savings strategy over a number of years, which is largely dependent on the tax rates between the sale of the original stock and the re-purchased stock and the growth rates of the stock.
Finally, while it may be a good idea to pay tax now at a lower rate; don’t forget to consider the time value of money – paying tax later compared to paying it now – and where the funds to pay the taxes will come from. Reducing the investment base (the principal) to pay taxes now, even at a lower rate, could hinder future growth at an extent greater than the tax savings. Seeking the advice of your investment professional is highly recommended for either approach.
*IRC 1091 - Wash Sales – When a taxpayer sells an asset for a capital loss and the same asset is re-purchased within thirty (30) days, before or after, the loss is disallowed.