On this week's Rule Breakers podcast, Motley Fool co-founder David Gardner brings in a special guest -- Megan Brinsfield of Motley Fool Wealth Management -- to assist him in explaining the ins and outs of tax-loss harvesting to a young investor who is looking to cut his IRS bill, but who still really believes in the current "losers" in his portfolio. That makes it tougher, because there are a number of rules the government has put in place to make this technique harder to implement.
A full transcript follows the video.
This video was recorded on Oct. 25, 2017.
David Gardner: Mailbag Item No. 3: Point No. 3. I'm bringing in a guest star for this one because I've already established how little I know: to wit, the last Mailbag item. And here's another thing that I'm not so great at, and that's taxes and talking about taxes, but this is a fine question.
Good news! I work at The Motley Fool, where we have experts on just about every financial topic that I could care about. One of them is taxes and I've got Megan Brinsfield, here, from Motley Fool Wealth Management joining me to help answer this question from Joshua Fung. Megan, welcome!
Megan Brinsfield: Thank you. I'm excited to be here.
Gardner: I'm so delighted to have you. And here's what Josh wrote. He said, "Hey, David. I was reading about tax-loss harvesting, and it sounds too good to be true. Up to $3,000 back on losses per year?" Joshua goes on to say, "I'm only 24, so 3K is quite a bit, and some of my favorite stock purchases this year are in the red." He mentions AT&T, Verizon, and Wells Fargo, none of which, by the way, are in the Supernova Universe. But anyway, back to the matter at hand.
Joshua goes on to say, "I love these companies, and if tax-loss harvesting is what I think it is, I'd like to sell and repurchase these holdings at their current price. However, I don't trust what I've read and I'd like to hear more about tax-loss harvesting from you. Any explanation would be greatly appreciated. Go Giants!" Sorry, Josh. They didn't actually make the World Series, this year. Megan, tax-loss harvesting. What does Joshua have right and what does he need to know?
Brinsfield: Well, the good thing is that Josh is in good company if he doesn't understand tax-loss harvesting. One thing to keep in mind is that you've sustained a loss, and so that's what you are writing off on your taxes. It's a deduction, so if you have $3,000 of losses, that applies against your other income. It's not like you're getting $3,000 back on your taxes.
So the first step is sell at a loss. The second step that he mentions is repurchasing, and that's where the quagmire starts, is going through all the rules associated with repurchasing stocks that you've had a loss on.
And the IRS agrees with you. This is too good to be true. A lot of people in the past were churning losses so that they could take losses on their taxes, and rebuying the stocks so they haven't substantially changed their economic position.
So the IRS said, "We're actually going to look at a window associated when you sell stocks at a loss," and this is called the wash-loss rule or wash-sale rule. And on the day that you sell a stock at a loss, the IRS looks 30 days in the past and 30 days in the future, and says if you rebuy that stock or a substantially similar stock, that you violated their rules and they say that you can't actually claim that loss.
So how do you get around it? Some experts say aside from the investing side of things, if you really like that company you could double up, double up your position at the cost now, wait 31 days, and sell your original holding at a loss, and maintain that second position in your portfolio. That does require carrying some additional risk for that period of time.
Let's say you don't want to double up or you don't have the capital to be able to do that. You could sell one of these stocks and replace it with a similar stock, or what a lot of people do is replace with an ETF or index fund so that you can be invested for that 30 or 31-day period without violating these rules.
So there are a lot of little complexities that can hang you up, because the wash-loss rules apply across tax years, in IRAs and non-IRAs. Sometimes for husband-and-wife couples. So you have to be really careful about making sure you don't violate that time frame.
Gardner: Wow, what a great answer. I realize there are contingencies involved in answering a question like that, and you're pointing out the importance of context, Megan. I guess in closing, No. 1, we're trying not to lose with every investment, anyway, right?
Gardner: So it's not really too awesome to lose in the first place. No. 2, I like the idea a lot that you could replace it with a similar stock that's not that same stock. Having just read Joshua's note, we know that he was pointing to AT&T and Verizon, and humorously I was somewhat snarkily remarking that none of those are my stock picks, but one of my stock picks that I really do like that's in the same space is T-Mobile, which happens to be eating market share from both AT&T and Verizon so that might be an example.
But in the end, Megan, let me ask. If Joshua feels like you've got to 92% of his question, but 8% is contextual or interesting, is there a resource? Where would he go for more information? A tax professional? Is that the answer? Or is there some cool site he could google?
Brinsfield: So there's a lot of information on Fool.com that's free information...
Gardner: I know that website.
Gardner: It wasn't even intended to be a product and sometimes I forget about our own stuff. Keep going!
Brinsfield: Yeah, so that's a free resource where you can get general information. And you google the term "wash-loss rule" and you'll get a ton of hits, so it's easy to get general information. If you want answers that are specific to you and your personal situation, that's the time when you need to seek out help from either a tax professional or a financial planner, and they can dig into your specific portfolio and scenario.
Gardner: Outstanding! Megan, it's great to see you. Is this your first appearance on this podcast?
Brinsfield: It is! I'm so happy to be here.
Gardner: Thanks! I can't believe I hadn't had you before. You and our other wealth planners at our sister company, Motley Fool Wealth Management, do this kind of work every day, I know...
Gardner: It's not cheap. This podcast is free. But if people were interested in finding out more about Motley Fool Wealth Management, what would they do then?
Brinsfield: You can check out our website at FoolWealth.com or send us an email at support@FoolWealth.com and someone on my team of financial planners will get back to you with an answer.
Gardner: Megan Brinsfield, thank you so much for being on this episode of Rule Breaker Investing.
David Gardner has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.