Boost your clients’ portfolio balances by strategically selling holdings at a loss to limit taxes.
- Tax loss harvesting is a strategy to reduce your clients’ tax bill (short- or long-term capital gains or ordinary income taxes) by selling holdings at a loss throughout the year.
- Those losses are then used to offset gains realized elsewhere in the portfolio, and can be reinvested with the potential to grow over time.
- For financial professionals, improving the tax efficiency of your clients’ portfolios may be more sustainable than consistently generating excess returns—particularly during periods of low or declining economic growth.
Excess return is not the only way to increase portfolio balances
Global economic growth is slowing. Fading stimulus, the lingering effects of the pandemic, persistent inflation, and the ongoing conflict in Ukraine are all contributing to the slowdown.
According to the International Monetary Fund's World Economic Outlook, growth is expected to slow from an estimated 3.2% in 2022 to 2.7% in 2023. This is a downward projection from January 2022.*
What does this mean for your clients? Muted return expectations, at least over the medium term. And, if you couple that with increased tax rates over the last decade, it’s difficult to know where financial professionals can turn to find reliable sources of portfolio alpha.
One potential source of that portfolio alpha is tax savings. Improving your clients’ tax efficiency may ultimately be more sustainable than consistently generating excess investment returns—especially in uncertain markets.
Tax loss harvesting is one tool to help reduce your clients’ tax liability and, by extension, boost their portfolio balances.
What is tax loss harvesting?
Tax loss harvesting employs the sale of securities in taxable accounts to realize a loss, usually to offset either short- or long-term capital gains or ordinary income.
However, it’s important to remember that tax loss harvesting only defers tax payments; it doesn’t eliminate them. But delaying the payment of taxes can allow your clients to keep more assets invested for potential growth.
Selling positions at a loss is not without risk. But if executed in a thoughtful way by a knowledgeable financial professional, tax loss harvesting has the potential to benefit both you and your clients.
How does it work?
Let’s consider how this approach might work using a hypothetical example—with and without tax loss harvesting.
Help your clients save on their tax bill through tax loss harvesting
Thomas earns $120,000 a year and is in the 24% tax bracket for both ordinary income and short-term capital gains. His long-term capital gains rate is 15%. Harvesting losses from a mutual fund that has declined by $15,000 and a stock that has lost $5,000 in value over the six months since he bought it, Thomas’ tax liability is decreased by $3,450.
While Thomas could potentially benefit from current portfolio losses in subsequent years through decreased tax liability, the advantage of working with a financial professional to do so today is that Thomas gets the cash savings sooner and can reinvest those savings (subject to the wash sale rule; see below) immediately.
Six core elements of an effective tax loss harvesting strategy
Selling a few underperforming holdings to save thousands in taxes may seem like an easy choice, but there are several factors that should go into a decision to pursue tax loss harvesting. Chief among them is your client’s overall investment strategy.
- Keep your eyes on the prize - Fundamentals like remaining diversified and staying the course over the long term are more important than short-term tax considerations. Ultimately, you want to make sure any tax loss harvesting activities don’t alter fundamental elements of your client’s portfolio, such as asset allocation and risk exposure.
- Focus on material losses – Many financial professionals assume tax loss harvesting should take place in December, but it’s a viable yearlong strategy. If you can make time for it, look for material losses—for example, 10% or more—to make it worth the effort.
- Look beyond individual stocks – If your client has a taxable account that contains mutual funds or Exchange Traded Funds with losses, it’s worth considering a sale of those holdings as well. If you purchase another fund to keep their allocation aligned with the original strategy, be careful not to invest in a fund that is “substantially identical” to the one you just sold; otherwise you’ll run afoul of the IRS’s wash sale rule (see below).
- Select the right cost basis – Understanding the implications of different cost basis methods on your client’s tax strategy is important. For tax loss harvesting on securities you may have purchased at different prices, select a method that allows you to sell holdings at a loss.
- Consider having dividends and interest paid out in cash – Another consideration is how to treat dividends and distributions in your clients’ taxable account. Dividend distributions often occur near the end of the year. Many investors have set up automatic dividend reinvestment and may forget that those shares acquired through dividend reinvestment may create wash sales.
- Understand the wash sale rule – The IRS wash sale rule is in place to discourage transactions made purely for tax purposes. A wash sale occurs when you sell or trade stock or securities at a loss and buy “substantially identical” stock or securities within 30 days before or after the sale (the “61-day window”). If you have a wash sale, the capital loss is not deductible that year.
Continue the conversation
For most people, delaying taxes is wise—and when executed successfully, a tax loss harvesting strategy can help minimize your clients’ current taxes and keep more money invested for the long term.
To learn more or to talk to a T. Rowe Price representative about our lineup of tax-efficient investment strategies, call 877.561.7670 or email email@example.com.
*Source: World Economic Outlook Report October, 2022.
All investments are subject to market risk, including the possible loss of principal. A tax-efficient approach to investing could cause a fund to underperform similar funds that do not make tax efficiency a primary focus.
This material is provided for general and educational purposes only and is not intended to provide legal, tax, or investment advice. This material does not provide recommendations concerning investments, investment strategies, or account types; it is not individualized to the needs of any specific investor and is not intended to suggest that any particular investment action is appropriate for you, nor is it intended to serve as the primary basis for investment decision-making.
T. Rowe Price Investment Services, Inc.., its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion contained in this website, including any attachments/links, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any tax penalties or (ii) promoting, marketing, or recommending to any other party any transaction or matter addressed herein. Please consult your independent legal counsel and/or professional tax advisor regarding any legal or tax issues raised in this material.
The views contained herein are those of the authors as of October 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
All charts and tables are shown for illustrative purposes only.
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