Harvest All Season Long: The Case for Year-Round Tax-Loss Harvesting
As the end of the year approaches, you may be helping clients minimize their tax burden and efficiently reach their year-end financial goals. For many, ‘tis the season for capitalizing on tax-loss harvesting strategies.
Although often viewed as an end-of-year strategy, I believe an advisor who wants to maximize the benefits of tax-loss harvesting for their clients should seek loss opportunities throughout the entire year, not just at the end of the year.
An advisor who considers tax-loss harvesting only at the end of the year may end up giving up significant tax value by missing market declines earlier in the year. The trajectory of this year’s stock market – large decline, followed by a large rebound – offers a detailed example of how a year-end tax-loss harvesting strategy can lead to missed opportunities.
Overview of tax-loss harvesting
When you have a portfolio of stocks, naturally some will increase in value and some will lose value over the course of a year. Tax-loss harvesting is a process of selling assets that have lost value in the past year and, ideally, replacing them with assets that have similar characteristics, so that a portfolio’s overall risk and return characteristics remain similar. Done well, this process can reduce your client’s tax burden, while maintaining similar pre-tax returns. The capital losses recognized may generally be used to offset capital gains or ordinary income, subject to certain limitations.
When harvesting tax losses, an advisor needs to keep in mind two pertinent aspects of the tax laws: 1) differentiating between long-term vs short-term capital gains and losses, and 2) the wash-sale rule. You can read more about both of these in our “Tax-Loss Harvesting: Now for Everyone” blog post.
Proactively seek loss opportunities
Capital losses recognized in the beginning of the year, or at any time, are generally just as valuable as capital losses recognized at the end of the year. For advisors who want to maximize their tax-loss harvesting strategy, the key is to be proactive and seek out opportunities to take losses throughout the calendar year, and not just in December. This strategy enables you to act when a portfolio experiences actual losses and use that loss to your advantage.
This year, in particular, illustrates this general idea. With severe market declines due to the pandemic, spring presented significant opportunities to harvest losses – at its low point, the S&P 500 declined approximately 30% from the beginning of the year. By December, the S&P was actually up over 10% year to date. In 2020, by far the best time for tax-loss harvesting was in the spring, not in December.
By harvesting losses when they are available, not just in December, you can proactively generate greater value for your clients.