Just over a month ago, we were dealing with wild stock market swings in the wake of the debt ceiling debacle, and market indices had fallen to levels where many of us were carrying paper losses. I thus suggested that it might be a good time to harvest some losses for tax purposes.
Harvesting our losses
I’m not sure about you, but I followed through and harvested a significant chunk of losses. The beauty of this is that you can carry unused losses forward indefinitely, and you can also use your losses to write off $3k/year in ordinary income, which is taxed at a higher rate than long-term capital gains.
Assuming a federal rate of 25% and assuming a state income tax rate of 6%, that $3k/year tax break works out to an annual savings of $930. And that will continue until we’ve used up our losses. Not bad for a few minutes work.
Anyway… When I made these moves, I ended up shifting money from the Vanguard Total Stock Market Index (VTSAX) into the Vanguard Large Cap Index (VLCAX). Thus, we were never out of the market, meaning that we’d be fully invested in the event of a quick rebound. While these two funds track each other rather closely, they follow different indices, so we’re also safe when it comes to avoiding a wash sale.
To make things easier on the back end (more below) and to avoid trouble with Vanguard’s frequent trading policy, I then converted our mutual fund shares into the equivalent ETF (i.e., I converted VLCAX into VV).
Returning to the issue of wash sales… To avoid triggering a wash sale, we weren’t able to move back into the Total Stock Market Index for 31 days (not counting the original trade date). Given that our original sale was made on August 10th, and that there are 31 days in August, we had to sit in VV until at least September 10th.
Note: To determine your wash sale window, simply pull out a calendar and count forward (or backward) 31 days starting with the day after (or before) your transaction date.
Making the roundtrip
While I’m comfortable with holding VV for the long term, my preference would be to get back into VTI (the ETF equivalent of the Vanguard Total Market Index Fund) if we could do so without incurring any gains. And guess what? Given the recent performance of the stock market, we’re not too far from being able to make that happen. Depending on how things go today, it might have even happened by the time you read this.
Assuming that I can make this roundtrip work, I will have banked a bunch of losses and our portfolio will look exactly as it did before the process started (albeit with some ETFs in place of regular mutual fund shares). While I’m not particularly interested in generating losses (who is?), we might as well make a bit of lemonade when the market hands us lemons.
8 Responses to “Tax Loss Harvesting, 31 Days Later”
D: That’s a common misconception about tax loss harvesting. We’re all interested in maximizing returns and making profits. But if the market happens to drop, there is nothing about TLHing that causes you to lock in a loss in real terms — unless, of course, you move from the market into cash. By swapping from one investment into another, similarly-performing investment, you are creating an immediate tax benefit without reducing your returns in any way, shape, or form.
I have nothing against paying my fair share of tax, as long as I got to keep the lion’s share of my profit. The more successful I am, it makes both the IRS and my self happier.
When I invest my money my main concern is to make money and not uncle Sam’s bite, which is nothing new for any individual with income.
I would rather make $100,000. profit, pay uncle Sam, keep the lion’s share in my pocket than write off this amount as a loss with the idea of making some savings on tax now or “may be’ in the future. None of us know what the future holds in terms of inflation, state of the economy, capital gain rate, our income, tax brackets and nasty divorce settlement. When we do not even konw if we will live up to retirement age, how can we be so certain that the decisions that we make today on pure assumptions f/the future will materialize.
I take loss only when profitability is non-existent, then I move forward to my next goal in good terms with uncle Sam and an uncompromised future.
Hmm. Note that I also left out the state tax benefit when running the numbers. So on $100k, your front-end tax savings would be more than $15k (and your back end gain would be commensurately higher). This would amplify the effects that I was talking about.
Re: Inflation adjustment… Not explicitly, but sorta. If you assume 3% inflation, then the 5% number is essentially the inflation adjusted version of the 8% scenario.
True, the situation is different if one has a large positive capital gain. If one has such an event it’s probably also more likely that net worth is high enough to make an extended cash out horizon possible.
Is your conservative 5% average gain inflation adjusted?
“If you can’t apply the tax loss to today’s income, the margin is likely zero, or even negative.”
Yes and no. If you hold to death, the extra gain is wiped away entirely.
Also, let’s say you’re carrying a big loss and (if you TLH) you’re able to use it to offset part of a huge gain associated with something like the sale of a business. You’re 30 years old and you’re not planning on liquidating your investments until you’re 65. By harvesting your losses, you get to invest the money that you would have otherwise paid in taxes for an extra 35 years. Yes, you’ll ultimately have to pay taxes on the “extra” gain, but you could come out *way* ahead.
Consider a $100k loss that you use to offset $100k in LTCG. That’s a $15k savings right now. Assuming a conservative 5% average gain over the next 35 years, your $15k will grow to over $80k. Just how high do you think cap gains rates will go? Enough for taxes on an extra $100k in gains to eat up that gain? Doubtful.
Sure, $100k is a big loss, but the numbers scale proportionally – for $20k in losses, just divide everything by 5. Oh, and if you bump that return to 8%, your $15k in tax savings grows to over $200k.
Someguy: Two things. First, you are correct that this essentially reduces the basis so future gains will be larger. That being said, I’m deferring those taxes far into the future — and potentially erasing them entirely, as any shares left as part of our estate will enjoy a stepped-up basis, wiping out that gain entirely.
Second, as you point out, I’m using these losses to offset income. It’s up to the reader to decide whether or not this is a good deal. In the 25% tax bracket, it’s a “real” savings of 10%. In higher tax brackets, it’s higher. I always use 25% for my examples because it’s a middle of the road value.
While it’s possible that cap gains rates could be higher in the future, they may not be. Who knows, maybe everything will be replaced with a consumption-based tax system. In that case, I’d come out way ahead, as I’d get to use the loss now without paying for the (larger) gain later.
Bottom line: I don’t have a crystal ball, so I typically make decisions based on what benefits me for the foreseeable future. Mix in a bit of gut feeling and some hunches, and I’m good to go. 😉
Maybe I’m naive, but I don’t think this is the awesome deal you’re making it out to be, Nickel. Yes, you are booking a loss now, but you are also lowering your basis by the same amount, so that when you eventually sell down the line (e.g., in retirement), you are going to “repay” the tax savings in the form of cap gains tax.
For example, you have $50K initial investment in a MF that is now worth $40K. You harvest the tax loss and have a $10K loss to offset cap gains or income tax. However, your basis on that MF is now $40K, so if/when you sell (or your heirs sell) 20, 30, whatever years from now, they are going to pay cap gains tax on an extra $10K.
So, assuming you can apply a tax loss today against income, really the savings is the margin between today’s cap gain tax rate and your current marginal income tax rate plus or minus any change in today’s cap gain tax rate versus the cap gain rate when you sell. If cap gain taxes are up when you sell, you could actually come out behind.
If you can’t apply the tax loss to today’s income, the margin is likely zero, or even negative.