By Lucas Felbel, CIMA®
Director, Portfolio Services
As Thanksgiving descends upon us in the U.S., Canadians (myself included) celebrated the holiday in mid-October, coinciding with the final farmers’ harvest. Simultaneously, the financial world experiences its own harvest season in October, Tax-Loss Harvesting (TLH) season. As we approach the conclusion of 2023, financial advisors engage in strategic meetings with clients, reflecting on portfolios and planning to add value in the remaining days of the year—and beyond.
TLH: The Intricacies
TLH is a nuanced strategy, involving the tactical sale of securities with unrealized capital losses to realize those losses for tax purposes. Subsequently, the proceeds are reinvested in similar but materially different securities to maintain market exposure and desired asset class alignment in clients’ portfolios. The realized losses can offset capital gains in other areas, reducing taxable income and limiting gains in various investment activities.
Captured losses can be carried forward indefinitely, providing a valuable tool for future tax planning. However, the efficacy of TLH is contingent on navigating the intricate Wash Sale rules.
Practice TLH Hygiene: Navigating Wash Sale Rules
The Wash Sale rule is a critical consideration in TLH, preventing the immediate repurchase of the same security within 30 days of selling. This regulatory safeguard aims to maintain the integrity of the tax-loss harvesting strategy by preventing a “double-dip” scenario where losses are claimed twice for the same security.
Crucially, the Wash Sale rule applies at the client Tax ID level, necessitating careful consideration when making subsequent purchases, especially across different accounts. For example, selling SPY for a $10,000 capital loss in a brokerage account and then repurchasing SPY in the same client’s IRA within the next 30 days negates the captured loss.
To navigate these intricacies, advisors can strategically purchase a similar security in place of the sold position. This approach allows clients to remain invested in the market, limiting cash drag, and preserving the overall investment strategy. For instance, tax-loss harvesting SPY for a $10,000 loss and purchasing VOO in its place for 30 days, or indefinitely.
Ideal TLH Candidates: The Stability of Fixed Income
Given the recent rise in interest rates, optimal TLH opportunities often lie within fixed-income positions. While clients may bemoan paper losses, these fixed-income assets offer stability over 30-day increments, making them prime candidates for TLH. Additionally, the reduced volatility allows for a smoother reversal of the TLH trade, minimizing the risk of short-term gains or market fluctuations.
‘Losses’ Redefined: Shifting Client Mindset
During TLH reviews, it’s crucial to reshape clients’ perceptions of realized losses. These losses are not traditional setbacks but rather non-depreciable assets with flexible applications. Advisors should emphasize the strategic benefits of offsetting gains and the long-term impact on overall portfolio taxation, fostering a more positive outlook among clients.
Carryforward Capital Losses: A Strategic Asset for Tax Planning
Captured losses can be carried forward indefinitely, offering a strategic asset for future tax planning. For example, if a client realizes a $20,000 capital loss this year and only offsets $10,000 in capital gains, the remaining $10,000 can be carried forward to offset future gains in subsequent years.
This carryforward mechanism provides advisors with a valuable tool to manage tax liability over the long term. It requires careful consideration in portfolio construction and ongoing monitoring of the tax implications of investment decisions.
Put TLH on Autopilot Year-Round: The Power of Direct Indexing
Direct indexing, especially through Dynamic’s Custom Indexing Solution, has emerged as a powerful tool for year-round TLH. This solution offers a daily TLH review, opportunistically capturing losses throughout the year. Direct indexing involves holding the individual securities in an index rather than the index itself, enabling more precise control over tax management.
Advisors leveraging direct indexing position themselves to navigate market downturns effectively, creating a reservoir of losses to offset future gains. The Custom Indexing Solution ensures a meticulous review of TLH opportunities, maximizing after-tax returns consistently throughout the year.
As advisors seek ways to enhance client outcomes, Dynamic aims to be the trusted thought partner in the complex landscape of investing. Acknowledging taxes as a potential blind spot, our team’s wealth of experience managing diverse client situations helps advisors elevate the value they bring to client interactions year-round, not just during “harvest season.” With detailed attention to the Wash Sale rules, the innovative use of direct indexing, strategic utilization of carryforward capital losses and a nuanced approach to TLH, advisors can cultivate a robust and dynamic strategy for tax-efficient investing for their clients.
For more information, contact Dynamic’s Investment Management team at (877) 257-3840, ext. 4 or investmentmanagement@dynamicadvisorsolutions.com.
As Director, Portfolio Services, Lucas Felbel, CIMA®, leads the implementation, monitoring and evaluation of trading activities at Dynamic Advisor Solutions.
Disclosures
This commentary is provided for informational and educational purposes only. The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. This is not intended to be used as a general guide to investing, or as a source of any specific recommendation, and it makes no implied or expressed recommendations concerning the manner in which clients’ accounts should or would be handled, as appropriate strategies depend on the client’s specific objectives.
This commentary is not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation. Investors should not assume that investments in any security, asset class, sector, market, or strategy discussed herein will be profitable and no representations are made that clients will be able to achieve a certain level of performance, or avoid loss.
All investments carry a certain risk and there is no assurance that an investment will provide positive performance over any period of time. Information obtained from third party resources are believed to be reliable but not guaranteed as to its accuracy or reliability. These materials do not purport to contain all the relevant information that investors may wish to consider in making investment decisions and is not intended to be a substitute for exercising independent judgment. Any statements regarding future events constitute only subjective views or beliefs, are not guarantees or projections of performance, should not be relied on, are subject to change due to a variety of factors, including fluctuating market conditions, and involve inherent risks and uncertainties, both general and specific, many of which cannot be predicted or quantified and are beyond our control. Future results could differ materially and no assurance is given that these statements or assumptions are now or will prove to be accurate or complete in any way.
Past performance is not a guarantee or a reliable indicator of future results. Investing in the markets is subject to certain risks including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed.
Investment advisory services are offered through Dynamic Advisor Solutions, LLC, dba Dynamic Wealth Advisors, an SEC registered investment advisor.
Photo: Winnipeg CTV News