One of Park Piedmont’s primary goals as a firm is to focus on thoughtful long-term planning for our clients’ financial lives. One important but often overlooked example of this planning involves tax-loss harvesting (TLH). As described in more detail below, tax-loss harvesting opportunities aren’t necessarily available every year. But when they are, as in 2022 and possibly this year as well, we want to make you aware of the potential benefits.
In years when market prices decline, selling certain investments for a loss can provide a silver lining by reducing taxes owed (hence the term “tax-loss harvesting”). Park Piedmont completed TLH for many clients in 2022, a year in which both stock and bond indexes had significant price declines. So far in 2023, stock and bond indexes have appreciated in value, but there still may have been declines this year for certain funds, as well as remaining declines from last year’s poor performance. Park Piedmont will be in contact later this month if your portfolio presents any TLH opportunities that could lower your tax bills going forward.
To understand how the TLH process works, it is important to know how different types of income are taxed. “Ordinary” income comes from wages, salaries, and self-employment income, and is taxed at Federal rates ranging from 10% to 37% depending on one’s tax bracket. “Capital gain” income comes from the sale of capital assets (e.g., stocks, bonds, and personal residences). Federal rates on capital gain income from assets held for a year or more (also known as “long-term” capital gains) range from 0% to 23.8%, which are significantly lower than those that apply to ordinary income. (Income from capital assets held for less than a year are referred to as “short-term” capital gains, and taxed at the higher ordinary income tax rates.) Most states also have ordinary income and capital gains tax systems.
Within a taxable, or non-retirement, investment account, the sale of an asset for more than what you paid for it results in a “realized” capital gain, while the sale of an asset for less than what you paid results in a realized capital loss. (Assets held in retirement accounts do not qualify for capital gains tax treatment.) Investments that have changed in value since they were purchased but haven’t yet been sold are said to have “unrealized” capital gains or declines. TLH is the process of realizing the capital losses that exist within a portfolio, which generate tax benefits described below.
Realized capital losses can be used to offset an unlimited amount of realized capital gains. In other words, if the amount of capital gains equals the amount of capital losses in a given year, no capital gains tax will be owed on the sales. Furthermore, if the amount of capital losses exceeds capital gains, then the capital gains will be fully offset and up to $3k of those losses can be deducted from ordinary income for that tax year. Additionally, any realized losses that exceed the amount of capital gains plus the extra $3k can be “carried forward” indefinitely and used to offset future capital gains and/or ordinary income based on these same rules.
Because of this carry-forward rule, TLH doesn’t just provide tax benefits in the current year; it can be a long-term planning strategy to minimize taxes. For example, if you plan to sell a home or concentrated stock position for a large gain, realizing capital losses in the present can provide offsets for these future gains. Gathering this kind of information is an important part of Park Piedmont’s planning work with clients.
There are additional details involved in TLH, and you should feel free to discuss these with your Park Piedmont advisor at any time. For now, we hope this general information gives you a sense of the planning opportunities that might be available.