Given the volatility in various financial markets, 2015 is shaping up as a year that will offer many investors ample opportunities for tax-loss harvesting.
Tax-loss harvesting, a strategy in which an investor sells one or more depreciated assets to offset the gains created by the sale of one or more appreciated assets, is a way to create tax efficiency and help achieve long-term goals.
In order to maintain the same asset allocation exposures, an investor simply replaces a depreciated asset with another, highly correlated investment, typically an ETF or mutual fund. The benefits of tax-loss harvesting depend on an investor's unique circumstances. It is mainly a way to offset unavoidable taxes owed due to capital gains.
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One common approach is to defer paying taxes on the gains until retirement, when many investors will be in a lower tax bracket. Another approach is to avoid paying capital gains taxes altogether via a charitable donation or bequest to an heir. Investors should seek expert advice regarding tax-loss harvesting strategies.
WASH-SALE RULE
When harvesting losses, it is important to be mindful of the wash sale rule, which prohibits taxpayers from claiming a loss when selling a security and, within 30 days before or after this sale, buying a “substantially identical” security or an option to do so. Buying and selling the same stock would be a clear violation of the wash sale rule, whereas buying and selling different actively managed mutual funds within the same category is generally considered a more conservative approach.
In the case of exchange-traded funds, the IRS has not issued guidance regarding buying and selling ETFs from different issuers whose ETFs utilize the same underlying index. However, a more conservative approach would be to purchase an ETF using a correlated, but totally different, underlying index. For example, an investor could buy an ETF using the FTSE index to replace a position utilizing an MSCI index, or vice versa.
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Volatility has been present this year in U.S. equities, international developed equities, emerging market equities, high yield bonds, commodities and other asset classes. As a result, there may be near-term opportunities for many investors to harvest tax losses in a manner that is in keeping with a well-thought-out, long-term financial plan. As such, investors should seek professional investment and tax advice regarding tax-loss harvesting strategies.
GETTING STARTED
How can you get started?
1. Review your portfolio for tax loss harvesting.
2. Be mindful of the wash sale rule.
3. Consider a conservative approach to assure the investments selected are not “substantially identical.”
Taxes are a year-round consideration. Don't wait until April to address tax-related issues—there are steps you can take now, with the help of your tax adviser, to prepare for tax concerns looking ahead. Given the volatility across multiple financial markets this year, tax-loss harvesting may be one strategy to help minimize the overall impact of taxes.
Charles Reinhard is a managing director and portfolio strategist at MainStay Investments, the mutual fund and ETF distribution arm of New York Life Insurance Co.
