Tax Harvesting: Wash Sale Rules Can Be Used To Your Advantage

Almost every culture has some kind of harvest celebration. Some of the traditions have been practiced for thousands of years. Here in the U.S, we celebrate Thanksgiving.

From a financial perspective, Thanksgiving starts many end-of-the-year activities. Now is the time to consider the tax consequences of the current year and implement any tax saving strategies. In 2007, I wrote about one one particular strategy known as tax loss harvesting. Over the last couple months I have been writing and talking about the fiscal cliff which is now the buzz in mainstream media.

But there is an interesting intersection between tax harvesting and the fiscal cliff which many people have overlooked.

The essentials of tax loss harvesting is to take investment positions which are currently worth less than you paid for them and sell them at a loss to offset other investment gains to reduce your taxable income. For example, if you have already recognized $10,000 in investment gains during the tax year you might consider selling other investments at a loss so your net income goes down, thus reducing your tax bill.

The "catch" in doing a tax loss harvest is known as the wash sale rules. The IRS says that if you sell an investment and repurchase a "substantially identical" investment within 30 days, they will disallow the tax loss.

There is a strong consensus that tax rates will be going up very soon. No one, as of yet, knows exactly how much or when, but many tax professionals are taking a different approach in 2012 and telling clients to increase their taxable income as much as possible this year as opposed to pushing it forward. The goal of this advice is to pay the lower tax rate now rather than a higher tax rate later.

The opportunity lies in the fact that the wash sale rules apply only to losses, not to gains. Suppose you own 100 shares of XYZ stock which you purchased at $20 per share and are now worth $35 per share. If you sell the stock now, you have to pay income taxes on the $15 per share gain with your 2012 tax return. If you owned the shares for more than a year it would be at long term capital gain rates, currently capped at 15%. So the strategy is to do just that, sell the stock but immediately repurchase the same shares at about the same price. You pay the tax on the $15 per share now, and going forward your taxes are based on your new $35 cost basis in the stock.

Taxes aren't always bad. Paying taxes means we have made a gain, but we may as well minimize the amount of taxes due on that gain. We would be happy to discuss this, or any other, tax or investment strategies with you.

On behalf of the entire DV Financial team, we wish you a very safe and happy Thanksgiving.

Tax strategies discussed are general in nature and not directed at any particular individual or situation. Please consult with a CPA or tax planning specialist before implementing any tax reduction or planning strategy.

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