Coronavirus Tax Opportunity (4/3/2020)
Coronavirus Tax Opportunity
The coronavirus is not only a serious health scare, it is also a serious financial crisis. Businesses are being forced to shut down and people are losing their income. The stock markets are reacting negatively as expected. While taking losses in our equity portfolio is never a good thing, it does present an opportunity to reduce taxes this year and into the future.
The process is called “tax-loss harvesting”. To explain how it works, I should start by defining a few terms:
- Tax-loss harvesting – A process of selling an asset at a loss and then buying a similar asset at a lower cost basis.
- Cost basis – The price you paid for an asset. In the case of mutual funds, the cost basis is adjusted upwards when dividends and interest are used to buy additional shares.
- Wash Rule – When you sell an asset at a loss, you have to wait 30 days before buying the asset back. If you buy the asset before the 30-day waiting period, it is called a wash sale and you can’t claim the tax-loss.
- Similar Asset – An asset that has the same characteristics as the one you sold but is sufficiently different so you do not run afoul of the wash rule. For example, selling one large cap growth fund and buying a different large cap growth fund.
- Carry-Forward – You can use the losses incurred when you sell an asset to off-set capital gains and up to $3000 of ordinary income. If you don’t use all those losses in the first year, you can “carry them forward” and use them in future years.
During periods when the investment markets are losing value, we use this opportunity to look at all our client’s portfolios to find assets that we can sell at a loss. However, for reasons I’ve stated in previous articles, we don’t want to be out of the market. It is important to stay invested during turbulent times to capture the up days. So, rather than just sell to realize a tax-loss, we immediately buy a similar investment. That way we are able to help our clients reduce their future taxes, stay invested in the markets and avoid the wash rule.
It can be hard to find the “silver lining” when our investments are losing value and sometimes that lining doesn’t shine brightly. However, by looking for tax losses to harvest and doing that correctly, we can use this opportunity to ease future tax burdens.