For tax season, we’re reprising a collection of articles on the subject of tax management. The following is the last in a series of five articles.
All too often, financial advisors view tax-loss harvesting as an end-of-year activity done to place clients in an advantageous tax position ahead of tax filing season. By making tax loss harvesting1 a year-round priority, advisors can increase the ongoing tax efficiency of client portfolios, helping them to maximize the value of their portfolios.
Volatile markets and changing economies can wreak havoc on even the most well-constructed investment portfolio. Implementation of an ongoing tax strategy – one that involves regular tax loss harvesting – can help advisors proactively seek to minimize the impact of taxes on their clients’ investment returns.
Disadvantages of Once-A-Year Approach
There are several disadvantages involved in limiting tax loss harvesting to the end of the year, which include:
- Lack of losses: Depending on how the markets performed, there may not be tax losses to harvest in December. Perhaps there were dips earlier in the year that could have produced tax losses, but by the end of the year, no losses exist for harvesting.
- Lost opportunities: If the markets are down, there may be a large number of losses to harvest, which could be missed by limiting harvesting to once a year.
- High portfolio turnover: Harvesting losses only once a year may require turning over a large portion of the portfolio at a single point in time, leaving the client’s portfolio looking quite different from its original design.
Tax losses are very valuable, because they can be used to offset gains and even some ordinary income. Such losses, especially short-term losses, are valuable and can be carried forward indefinitely.
Regular tax loss harvesting can help clients avoid a situation where gains have been realized, but there are no losses to offset them, which would likely require the payment of capital gains taxes. Short-term losses can be especially valuable because they can be used to offset short-term gains, which are taxed at ordinary income rates.
That being said, if a loss is a small one, it may not make sense to realize it due to transactions costs involved in selling and the fact that because “wash sale rules”2 prevent clients from buying back the same security back within 30 days.
A final word: efficiency
For advisors and their clients, tax loss harvesting has the potential to yield concrete benefits for client portfolios over time. One potential approach for implementing ongoing tax management is an umbrella structure such as a Unified Managed Account (UMA). In a unified managed account, tax-aware professional overlay managers who possess the tools to monitor individual client account tax situations can help implement tax-efficiency solutions.
Additional market analysis and information on portfolio construction is available on durableportfolios.com.
1 “Tax loss harvesting” refers to efforts to offset capital gains tax liabilities.
2 “Wash sale rules” refers to an Internal Revue Service (IRS) rule that prohibits individuals from claiming a loss on the sale or trade of a security that is sold at a loss.
Tax loss harvesting is not suitable for all investors. Investors should consult with an investment professional prior to making any investment decision. Use of overlay management and tax management strategies does not guarantee a profit or protect against a loss in an investor's portfolio.
Natixis Global Asset Managment does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
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