Tax Efficient Investing Tips

In December, we all get busier preparing for the holidays, buying gifts, attending holiday parties, traveling to see family, and spending more time with children and grandchildren.

It can be easy to forget about planning and investments for a while. However, amidst the holiday hustle & bustle you don’t want to overlook your annual opportunity to manage taxes through tax loss selling.

First a disclaimer, we are not in the tax advice business. The goal of this article is to describe the mechanics of a commonly used investment management opportunity that may help reduce capital gain taxes, but that may or may not exist for you. So, before taking any action that may impact your specific tax situation, consult your CPA or tax advisor.

In a year when stock markets have gone up considerably, it can be harder to offset gains with losses, however a well-diversified portfolio may have holdings in other asset classes that offer some actionable opportunities.

As a side note, realizing an investment loss does not necessarily mean you’ve made poor investment decisions. For context, famous Boston Red Sox slugger Ted William’s record-breaking career batting average was only .400.  Said another way, Ted failed on 6 out of every 10 tries, yet he was the most successful hitter of his era.

While this is not an exact comparison, investing can be looked at in a similar way. Not every single investment decision will work out, but, successful investing does not require a 100% ‘batting average’. The key is to hold winners and pare back the losers rather than waiting forever to get back to “even”.

Current IRS tax code allows realized capital gains to be offset dollar-for-dollar by realized capital losses. Only realized losses from non-passive investment activities can be used to offset realized gains from other non-passive investment activities. A non-passive investment activity could be the purchase or sale of a stock or bond, mutual fund, or certain ETF’s.

Conversely, passive investment activity could be the purchase or sale of a limited partnership, an LLC, rental real estate, rental equipment and certain real estate transactions.

Let’s look at a simple tax loss selling example. First, we’ll assume that you made an early investment in a successful microchip maker, and this year you decided to realize a $10,000 capital gain from your microchip position.

Next, assume you own a position in a biotechnology company that is developing a promising new medication. Sometime after you bought the biotech stock, a press release detailed unfavorable clinic trial results for the medication.

Assume further that because of the bad news, the price of the stock dropped, and your initial $20,000 investment is now only worth $10,000. Your biotech investment might be a good candidate for a tax loss sale. In this example, the loss could offset the entire realized gain from the sale of your microchip maker.

The key to tax loss selling is to offset realized gains with realized losses while maintaining the integrity of your portfolio structure and investment strategy. What does that mean?

The structure of your portfolio is about common risk controls like asset allocation, the number of holdings in your portfolio, the maximum size of individual investment positions, or the minimum and/or maximum exposure to GICS sectors or certain types of investments.

For example, if your asset allocation has a 65% target for equity/stock holdings, you’ll want to try to maintain that target even after selling positions to realize a loss.

Your investment strategy is more refined to your individual goals, objectives, and investment preferences as well as the way in which investments in the portfolio are bought and sold and managed.

For instance, if your investment strategy includes a specific % exposure to the biotechnology sector and you sell a biotech holding to realize a tax loss, you’ll want to replace it with a substantially different biotechnology holding to maintain your strategy.

Also, be aware of wash sale rules. A wash sale occurs when you buy the same security (or a substantially identical investment) that you sold for a realized loss within 30 days (either before or after) the latest sale of that security.

A wash sale effectively nullifies, or wipes away, the realized losses (for tax purposes) in the security you sold.

In conclusion, done properly, tax loss selling can be an effective tax management strategy. Always consult your tax advisor for advice and details on IRS rules and tax ramifications of your actions. And be sure to consult with your investment adviser to discuss whether you have any tax offset opportunities and for portfolio management advice.



This material is provided by Schmitt Wealth Advisers for informational purposes only.  It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product.  Schmitt Wealth Advisers does not provide tax or legal advice, and nothing herein should be construed as such
. Opinions expressed by Schmitt Wealth Advisers are based on economic or market conditions at the time this material was written.  Economies and markets fluctuate.  Actual economic or market events may turn out differently than anticipated.  Facts presented have been obtained from publicly available sources (unless otherwise noted) and are believed to be reliable.  Schmitt Wealth Advisers, however, cannot guarantee the accuracy or completeness of such information.  Past performance may not be indicative of future results.


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