It is the time of year when investors look at their books and see which losing securities they can shed to trim their tax bills—but they may have little to work with this year.
Investors can lower taxes on their capital gains—which face ordinary income rates if held for a year or less—by selling at a loss certain shares that have dropped in value. Depending on the extent to which losses eclipse gains, investors can offset up to $3,000 in income, and what’s left over can be carried to future tax years.
But wealth advisers have fewer options for raising their clients’ post-tax return this year, as markets have maintained a steady ascent in 2019. The Nasdaq Composite Index has brought in a 30% return so far, the S&P 500 Index has risen 25%, and the Russell 2000 index and Dow Jones Industrial Average are each up about 20%.
“There’s just not going to be as many opportunities for tax loss harvesting this year as there have been in the past,” Chad Norfolk, a partner and senior client adviser at WMS Partners in Maryland, said.
Norfolk said his firm is increasingly advising clients to instead consider charitable donations of equity that has risen in value, as they can not only avoid the capital gains tax, but get a deduction equal to the market value of what they donate. It is also a much easier strategy in a bull market, when gains are in abundance.
Weeding Out the Losers
Still, there are candidates out there for loss harvesting—Chinese tech companies and the pharmaceutical and energy industries are some examples, said Mike Landsberg, a CPA and director at the wealth advisory firm Homrich Berg in Atlanta.
Although 2019 generally saw big gains, he said, “it’s prudent to take a look—even if there aren’t many losers.”
While particular sectors might also include a mix of winners and losers, the same can be said for particular lots, or groups of shares, of a single company. It may have shown steady growth over a decade, but had a bad year, and a sale could mean offsetting that higher short-term capital gains rate, practitioners said.
“You can go in there and just specifically choose a lot to sell,” Landsberg said.
Playing By the Rules
Although many brokerages and trading platforms have eliminated trading fees, those fees aren’t totally extinct, and could eat into those additional after-tax returns, wealth advisers said.
Investors also need to avoid tripping what is known as the “wash-sale rule,” which bars them from selling a security at a loss and buying a “substantially identical” one within 30 days of that sale. The rule, meant to keep investors from selling just to claim a tax benefit, applies to other brokerage accounts and tax-exempt retirement accounts held by the individual making the sale.
And while not buying the same stock again is straightforward, steering clear of the rule with shares of mutual funds and exchange-traded funds that often follow the same indexes is not, wealth advisers said.
“There is no formal definition of what ‘substantially identical’ means,” said Brian Ellenbecker, a senior financial planner at Robert W. Baird & Co. in Milwaukee, Wis. “It’s a gray area. I like to say, ‘If you are sitting down in front of an IRS agent and they are asking about your position, it’s on you to answer.”