Turn portfolio losses into a win. Here are three ways to cut your taxes
There’s a silver lining to this year’s down market — the opportunity to offset any capital gains by selling stocks at a loss. Tax-loss harvesting is a key theme for year-end planning as investors try to offset the tax bite from capital gains elsewhere in their portfolio. It’s a strategy that applies to taxable brokerage accounts. “As irrational as it may be (this is an example of ‘anchoring bias’), tax loss harvesting can help you refocus your attention on the progress that you’ve made in your long-term investing journey, which is far more important than a short-term snapshot of recent (and temporary) losses,” said Daniel Scansaroli, UBS’s head of portfolio strategy and UBS Wealth Way Solutions. High-income families typically benefit the most from the tax strategy, but the size of the benefit is affected by a number of factors — including your taxable income, tax rates, your time horizon and your asset allocation, he said. There are a few things to keep in mind before partaking in tax-loss selling, including what’s known as the “wash sale rule.” That rule states you can’t buy and sell the same security within 30 days of one another. So, you are unable to sell your losing stock to offset a gain, and then buy it again within 30 days so you can get the upside when it rebounds. Here are three strategies to reduce your tax burden. 1. Tax swapping With this strategy, you sell your original investment and use the proceeds to buy a replacement asset. “A best practice for implementing a tax swap without missing out on a recovery rally — and without running afoul of the wash sale rule — is to use a replacement investment in the same asset class as your original investment,” Scansaroli said. For instance, that could mean selling shares of Coca-Cola and buying Pepsi. 2. Doubling down There may be some cases when you can’t easily find a replacement investment for the one you want to sell. However, if you sell your original investment and then wait 30 days to buy it again, there’s a risk that you’ll miss out on any gains during that time frame, Scansaroli said. If you are worried about possibility, you can use a “doubling down” strategy. Once you know which security you want to sell, purchase additional shares of it before making a sale. Then, wait until after the 30-day period to sell your original assets. With this strategy, you’ll need extra cash to make the purchase since you won’t have the proceeds of the prior sale. There is also the chance you could see more losses if the investment continues to fall. Conversely, the security could rally back in that 30-day period and you won’t be able to sell it at a loss to offset your capital gains. 3. Tax management overlay The best approach is to make small and consistent loss harvesting trades throughout the year because markets tend to go higher over time and losses are usually short-lived, Scansaroli said. That would mean using a systemic approach that continuously monitors each position. With a tax management overlay strategy, your manager considers your tax cost whenever making a portfolio adjustment, he said. “In addition to finding loss harvesting opportunities, a tax management overlay strategy can help you to manage the impact of capital gains from planned sales — for example, they can postpone a trade if you are close to getting long-term capital gains treatment,” Scansaroli pointed out. — CNBC’s Michael Bloom contributed reporting.