Given that it is late in the year and we are currently in a bear market, we can find some solace in actively looking for opportunities to tax loss harvest (TLH).
TLH involves a series of steps. Curran sells securities that have lost value, which in turn allows the investor to offset capital gains on profitable securities transactions. We then replace the sold securities with a proxy investment, similar to the sold investment but not identical as to run afoul with the IRS by creating a wash sale, more on wash sales in the next paragraph. The reinvestment of the sale proceeds allows the investor to maintain the desired investment exposure.
The wash sale rule prohibits investors from selling an investment for a loss and replacing it with the same investment 30 days before or after the sale date. The wash sale rule is an IRS regulation that prevents the taxpayer from realizing and claiming a loss when violating the rule. The rule would also apply if selling a stock such as Apple then turning around and buying Apple options within 30 days of the sale. The option gives the owner the right to buy shares, Apple shares in this example, which the IRS would consider a substantially similar investment, even if the investor does not exercise the option resulting in the receipt of shares. The wash sale rule also applies to an investor’s spouse or a company they control.
There are other risks and issues to consider when engaging in TLH. For instance, long term investors are only deferring the taxes. Usually, the TLH stems from the state of the overall stock market and not necessarily anything specific to the company. Our fundamental basis for owning the shares remains intact. Otherwise, we would sell the shares outright at a loss and buy another company’s shares as a long-term investment. Some emphasize that by TLH one has simply kicked the proverbial tax can down the road. By lowering one’s cost basis the investor could wind up paying more in tax at the time of future sale, assuming a gain than if they did not engage in TLH. Invariably, TLH results in a lower tax basis which in turn will result in a larger realized capital gain when selling the shares at a future date as illustrated in the hypothetical sequence of trades below.
At Curran we also avoid TLH near a company’s earnings announcement. This time let us use Nike as an example. A company’s earnings announcement tends to increase volatility in the share price. Good news can result in a spike in the share price, whereas bad news can send the share price lower. Nike announced its earnings and held a conference call for investors after the market closed Tuesday, December 20th. Investors liked the results and found the company’s proposed cost cutting measures over the next year encouraging. The following day, the share price soared over 13% higher and yet again higher the next too. The Investment Committee’s review process identified modest client losses in Nike shares. Examining Nike’s corporate calendar over the coming days and weeks we could see that the company would be announcing earnings within the next 30 days. As a committee, we decided to postpone TLH and are we ever glad we did. Realizing a loss would have meant missing the jump in Nike’s share price. When TLH, there is always the risk of repurchasing the shares at a higher price after the 30- day waiting period. In this instance, that would have been a near certainty.
I authored this article to point out that there are pitfalls to TLH. Not all investors see the downside or risks, many only see the advantages. At Curran, we are certainly in favor of realizing losses. However, we do so judiciously for the reasons and examples outlined above. We realize losses to help offset capital gains. Given our long-term investment horizon, low turnover investment philosophy, and over a decade of higher markets, long-term investors have accumulated considerable capital gains across their holdings. Selling shares for fundamental reasons invariably results in capital gains. Our investors should know that the Investment Committee has evaluated losses this year for TLH to help offset realized capital gains. At Curran we wish you happy holidays and higher markets in what we hope will be a merry new year!
Kevin T. Curran
Co-CEO & Chief Investment Officer
At Curran we value service over sales and believe quality service yields happy clients. Below is our 4-step process (the first three steps at no cost to you).
A short introductory call for us to get to know one other. During this call we will discuss your financial goals, concerns and hopes for the future.
In this meeting we will go over your current financial situation, take a deeper look at your goals, discuss your risk tolerances, and collect the data necessary to build a formal proposal.
Based on our data gathering session, our Private Wealth Managers will present you with a custom proposal tailored to your needs. We encourage individuals to take the time to evaluate this proposal.
If you are comfortable with the proposal and choose to invest with Curran, our team will be there every step of the way assisting in opening the recommended accounts and facilitating all necessary parts of your onboarding process.