When you sell an investment at a profit, you will owe capital
gains taxes on the money you make. Fortunately, investors can take steps to
minimize the capital gains taxes they pay and keep more of their money in their
own pockets. Choosing the right kinds of investments, and choosing the right
vehicles for those investments, are two ways to cut down on Avoid Capital Gains Tax without
impacting the return on your investment.
Who has to pay estate taxes? 6 Things You Probably Didn’t
Know About Tax-Loss Harvesting
For decades tax-loss harvesting was an obscure tool to Minimize
Capital Gains that was only available to the ultra-wealthy. Many pundits and
industry professionals who were unfamiliar with its benefits thought it
couldn’t add much value. Well times have changed and now many investment
management firms offer a version of tax-loss harvesting.
Tax-loss harvesting derives its benefit from the combination
of tax-rate arbitrage and the compounding of your annual tax savings. Many
people mistakenly believe that tax-loss harvesting provides no benefit because
you must ultimately pay a Tax On
Capital Gains that results from the lowered cost basis achieved through
tax-loss harvesting. What they fail to realize is the tax rate you pay on the
ultimate gain is almost always lower than the rate at which you can benefit
from your harvested loss. That’s because your loss creates value at the
short-term capital loss rate and the ultimate gain is taxed at the much lower
long-term capital gains rate.
Tax-loss harvesting is only appropriate for long-term
investors. There is no benefit to tax-loss harvesting if you plan on holding
your portfolio for less than one year because you cannot benefit from the
aforementioned tax rate arbitrage or compounding. The annual value of tax-loss
harvesting increases as your investment horizon increases because your savings
continues to compound throughout. As such, tax-loss harvesting is likely more
valuable to millennials who have the opportunity to save and invest for many
more years than baby boomers who are close to retirement.
Your benefit from tax-loss harvesting will likely increase if
tax rates are raised. Again, because of tax rate arbitrage, an increase in
rates at least a year before you withdraw your money from your tax-loss
harvesting account will actually increase your benefit. If long-term capital
gains rates increase by more than ordinary income rates (which seldom happens)
then the benefit of tax-loss harvesting will decrease, but will still be
substantial. The only circumstance that could significantly impact your
tax-loss harvesting benefit is if rates increased in the specific year in which
you planned on withdrawing all your funds.
One wash sale does not eliminate the benefits of your overall
harvested losses. The wash sale rule governs whether realized losses may be
used to offset ordinary income and realized Avoiding Capital Gains. It states that
you may not offset your taxes with a recognized loss if it results from the
sale of a security that is replaced with a substantially identical security 30
days before or after the sale. ETF-based tax-loss harvesting services avoid the
wash sale rule by replacing an ETF that trades at a loss with another ETF that
is highly correlated, but tracks a different index. The IRS does not consider
ETFs that track different index’s to be substantially identical.
You get more benefit from tax-loss harvesting the more
frequently you add deposits to your account. Advisors not familiar with
tax-loss harvesting tend to view it through their primary experience, which is
with older investors who are in the wealth preservation stage of their lives.
As a result these investors tend to make only one deposit when they open a new
investment account. In contrast, young investors are in the wealth accumulation
phase of their careers so they tend to consistently add to their investment
accounts over time. The greater the number of deposits, the greater the number
of tax lots with which tax-loss harvesting can work, which translates to more
total annual benefit.
Tax-loss harvesting can work well even after you retire. Once
again, the longer you allow your money to compound, the greater the benefit
from tax-loss harvesting. It is highly unlikely that you would withdraw all
your retirement savings on the date you retire. Rather you are likely to
withdraw a relatively small percentage of your retirement account each year.
The slower the rate at which you withdraw, the higher the annual compounded
benefit from tax-loss harvesting, even accounting for the taxes due upon
withdrawal.
For More
Information Minimize
Capital Gains
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