Almost no one actually likes thinking about their taxes. That's a big part of why so many people wait until mid-April to file them, and why it's so common for taxpayers to miss out on lucrative tax breaks because they don't get things taken care of before the end of December. Even those who are more diligent about their tax planning often procrastinate until the last few weeks of the year to get their ducks in a row and cash in on valuable deductions, credits, and other favorable tax rules.
Yet in some cases, waiting until the bitter end to claim a tax benefit can end up being less lucrative than making the same move sooner. That can be the case with tax-loss harvesting, which is an extremely popular strategy that helps you get a tax break from losses in your portfolio. By getting a jump on your tax-loss harvesting, you might get better results than those who wait until the last month of the year.
The basics of tax-loss harvesting
One of the biggest benefits that investors get is that if you don't sell a stock, you don't have to worry about gains or losses in its value over the course of a year. Unlike some other countries, the U.S. doesn't tax individual taxpayers on unrealized gains or losses in their investment portfolios. Only when you sell shares will you have a capital gain or loss to deal with. That means that if you have an investment that is down and you want to claim the loss for tax purposes, you have to make the conscious decision to sell that asset.
Tax-loss harvesting can cut your tax bill in two ways. If you have capital gains from asset sales elsewhere in your portfolio, you can use any and all losses you lock in to offset those gains. Moreover, if you still have losses left over even after offsetting all your capital gains for a given year, most taxpayers can use up to $3,000 of capital losses to offset other types of income, ranging from wage and salary income to interest, dividends, or distributions from IRAs or other retirement plans.
The advantage of harvesting early
In addition to general procrastination, many taxpayers delay harvesting their losses in the hope that it will prove unnecessary. Admitting that a stock is a loser is difficult, and some doubtless hope that waiting an extra couple of months will bring a year-end rebound that will wipe out some or all of their stocks' declines.
Unfortunately, what often happens is the opposite. Professional investors know in advance which widely-held stocks have gotten hit hard in a given year and are therefore likely candidates for tax-loss harvesting. They can anticipate that those stocks will see a lot of selling from shareholders in the last couple of months of the year. Therefore, those pros are likely to sell early, in the hope that they can buy back shares on the cheap during that rush of year-end selling.
That's especially true for institutional investors like mutual funds. Many mutual funds have to make sales before the end of October in order to have them count for tax purposes. By the beginning of November, their selling period is therefore over -- and any damage it will do to the stock price has already been done.
2 benefits of being first in line
Those who get their tax-loss harvesting done early, on the other hand, can get a jump on their peers. Selling sooner can mean getting a higher share price. That'll reduce the size of your tax benefit, but it'll also mean you're losing less money overall, which is a far better result.
There's also an advantage for those who still believe in the stocks they're selling to harvest tax losses. In general, investors are legally required to wait more than 30 days to repurchase a stock they've sold if they want to claim a loss on the sale. These wash sale rules mean that those selling in December will have to wait until some time in January at the earliest to repurchase their shares, potentially missing out if there's a New Year's rally. By contrast, those who sell in October can repurchase shares in November or December -- hopefully at even more attractive prices as other investors do their harvesting closer to the deadline.
Worth a closer look
Short-term market timing is typically not worth pursuing, and there's no guarantee that harvesting tax losses sooner rather than later will prove to be the right move with your specific stocks or your particular timing. However, if the prospect of a slightly better result motivates you to get some tax planning done early, that could also free up more time for you at the end of the year for more important pursuits.
