PFFAP-PYP-23-0726-Tax Loss Harvesting
Voiceover: [00:00:00] This show is for educational purposes only and is not personalized advice. Consult your tax advisor before taking action. All investments involve risk of loss, past performances, no guarantee of future results. Reach show notes for full disclosure.
Welcome to the Physician Family Financial Advisors podcast, where physician moms and dads like you can turn to today's worries about taxes and investing into all the money you need for retirement in college.
Nate: Hello, physician moms and dads. I am Nate Reineke, certified Financial planner and primary advisor here at Physician Family Financial Advisors.
Today we are gonna talk about yet another way to save on taxes. We're gonna talk about tax loss harvesting. You may have heard about tax loss harvesting. Wondered if it was a good thing to do, if it was right for you. And it's a tough question. So we brought on, uh, an expert. Physician Family Advisor and certified financial planner, Kyle Helsley.
Hello, Kyle. [00:01:00]
Kyle: Hello. Thanks for having me back.
Nate: Yeah, welcome back. So tax loss harvesting is something that everyone's heard about, I'm assuming, or at least if you read about personal finance, it's a fun thing for those bloggers to talk about something we, you talk about, I mean, at least a few times a week, probably, especially if people are experiencing some losses in their investments.
But I think. Something that's important to start the call, or sorry, call. I'm, I'm acting like I'm working to start the podcast. It's pretty unique to each investor, so everybody has a different circumstance and sometimes you should harvest your losses and sometimes you shouldn't. So instead of getting into those details, I think we should talk about what it is and at a high level, kind of explain how to go about making this decision.
Sound okay? Sounds good.
Kyle: Sounds good. Yeah, let's do it. Okay.
Nate: Alright. So first my question for you Kyle, is, what is [00:02:00] it? So what is tax loss harvesting? It's when an
Kyle: investor, uh, actively sells an investment for a known loss in an effort to, uh, realize that loss and use that loss as a deduction on their taxes in an effort to reduce their overall tax bill.
Nate: I see. Okay. And when, uh, when folks ask me about how to lower their tax bill, most of the time when it comes to their investments, it doesn't feel like there's a whole lot they could do. You know, there's not a whole lot of things. They can actually lower their tax bill when it comes to their income. But you're saying this is a way to do that?
That's correct. Okay. So, um, let me think about this. So if, if you have it to lower your taxable income, You have to do tax loss harvesting, [00:03:00] and that kind of assumes that you have a loss. So, uh, can you explain what a tax loss actually is?
Kyle: Yeah, it's, we're, you know, the, the best example to use would be like a mutual fund, you know, a really common investment, like a mutual fund.
Mm-hmm. And, uh, you buy it for, for a share for, uh, a price. You know, you pay a share price when you buy it, and if the value of that. Mutual fund share goes down and you sell it. After the investment has lost value, then uh, you effectively have realized a tax loss. And so, um, so basically the investment, you bought lost value, you sold it, and you're allowed to report that loss on your taxes as a tax loss.
Nate: I see. Okay. So let's say someone lost $10,000. How much do they actually get to write off on their taxes? Do they get to write off the whole 10? [00:04:00]
Kyle: That's a good question. Um, you're limited by the i r s of being able to deduct 3000 in tax losses per year max
Nate: for the year 3000. So would you only want to, uh, harvest $3,000 worth of losses?
Kyle: No, actually. 'cause there's actually another, uh, piece of the puzzle here, which is, uh, the i r s graciously lets you carry forward your losses indefinitely. So in your original example of a $10,000 loss being realized, uh mm-hmm. You can deduct 3000 in year one. 3000 in year two, 3000 in year three, and the remaining 1000 in year four.
And at that point, oh uh, that loss would've been used
Nate: up. I see. Alright. So you get to carry it forward as long as you, uh, still have a, a loss to, to [00:05:00] carry forward. You can continue to do it until it's gone. That's correct. That's interesting. Okay. I imagine, um, You could have a, I mean, some of the accounts that we're looking at, there's, you know, millions of dollars in there.
Right. And so if there's a reasonable loss, you could have decades of losses to carry forward. So that's a pretty big benefit if, if you are in the situation where you do have a, a big loss. Am I getting this right? That's
Kyle: right. Yeah. If you realize a, a substantially large loss, you know, let's use a nice even number, like $30,000 loss is what you realize.
Mm-hmm. And you can deduct 3000 a year. Quick math tells you that that's 10 years worth of deductions that can carry forward. Hmm.
Nate: Okay, so there, there's the big, the big benefit here. So, um, something that. I think a lot of people think about is they, they know they may have some losses, especially like in a down [00:06:00] year.
I mean, you ha may have some, some investments that you purchased a long time ago and they have gained so much in value that they'll never see a loss. But, uh, when, when we're advising people on how to invest, they're investing every month. So there's some really recent, uh, I guess investments that they've purchased that might have a loss, even if the market's only down a little bit year over year.
So h how, like how do they know that it's ready to write off on their taxes? Like, can they just go write it off? Or what do they have to do to actually uh, get this break?
Kyle: Yeah, so there's the, the steps in the process is. First of all, you need to identify if, if you even have any losses. And so, um, before I, before I jump into that, it's important to know the difference between, uh, what's a realized loss and what's an unrealized loss.
So an unrealized [00:07:00] loss is, uh, when the investment that you purchased is showing a loss, meaning the value is less today than it was yesterday when you bought it, uh, but you haven't sold it yet. That's an unrealized loss 'cause you haven't actually sold the investment and. And, and, uh, you know, physically captured that loss.
You know, it's, as long as you still hold the investment and you haven't sold it, it's considered unrealized. But as soon as you pull the trigger on the sell trade and you sell that investment for the loss, you have just realized that loss. So I
Nate: see. Yeah. So something that I hear, you know, the, the famous investors, they'll say how the average person will say, I lost money this year in this, in, in the stock market.
And they respond, well, I didn't lose money. And then they say, but I didn't lose money simply because I didn't sell. Is that what you're talking about? Because if you just hold onto something, You didn't [00:08:00] actually lose any money until you actually sell it for a loss, and then, and that is normally talked out about as bad, but in this situation, you must do that to get the tax benefit.
Is that correct?
Kyle: That's right. Yeah. Yep. You have to sell an investment for less than you paid for it. That's, that's the downside. Okay. Okay.
Nate: Okay. And so my mind spinning here with what I, I'm, I'm thinking back to my C F P studies. I'm thinking about something you could do with these other things you could do with these losses and all that.
But first I'm, I want to know like, what is the downside of selling? I'm imagining these people are buying investments they like, so yeah, the market's down, but what's the downside of selling, uh, to get this or to harvest this loss? Like you're selling an investment. So then what do you do with the money?
Kyle: Yeah. Yeah. I mean, the big downside is if you spend a lot of time and effort into carefully choosing your favorite investment and you put your money into it. [00:09:00] Mm-hmm. And you're plan on holding this for a long time. Right. You know, say it's for retirement, a mutual fund for retirement, you pick your favorite mutual fund, you might plan to hold this mutual fund for 40 years.
Mm-hmm. But, You know, there's gonna be some periods, like you said, if someone's saving on a monthly basis, some of those purchases will be at losses and some of those purchases might be at gains. And so what you're, what the downside effectively is, is you have to sell an investment that is your favorite investment.
Mm-hmm. You know, you have to sell a piece of that off. Um, and then, You've harvested. So let's say now that you've, you've realized the loss and you're excited about that, 'cause you have to put it towards future incomes as a, as that $3,000 deduction up to 3000 per year. And, but now you have this cash, you know, you sold the position, you realize the loss.
Now there's cash sitting there. So what do you do with the cash, you know? Mm-hmm. Um, do you leave it in cash? Do you buy another investment? [00:10:00] Um, But what you can't do is buy immediately within, within 30 days of selling that that investment, you cannot buy immediately back into that investment for 30 days.
You have to wait 30 days. It's called a wash sale. Mm-hmm. A wash sale Sale. Yeah, a wash sale. Oh, so that's the
Nate: term probably people have heard. Yeah. I'm remembering, uh, this, now I'm remembering back to. Uh, reading about this. So wash sale is, the tax man doesn't want you to get the tax break and then just buy right back into the investment.
So it's like a, they, they close the loophole where you just buy right back in. Is that right? Because then, then it would, you're not really experiencing a loss if you sell it and then buy it back the next day.
Kyle: That's right. Yeah. They, they're trying to prevent people from selling something. Just the harvest, the loss, um mm-hmm.
And then, and then, you know, and then, So how they do that is they prevent you from buying right back in to that same fund. [00:11:00] Um, ideally they want you to sell the investment for some other reason, like you don't wanna hold it anymore or you want to buy something different or maybe you need some cash for, uh, to spend or something.
You know, there needs to be some other reason that you realize that loss other than just to get a deduction. Mm-hmm. So they make you cool your heels for 30 days.
Nate: I see. Okay. Alright. So there's the, therein lies the problem. Like, why you wouldn't just do this, you know, with every, every chance you could possibly get.
Now, uh, still seems like, uh, for physicians who are paying 40% in taxes that this is a good deal, but it's just, it just makes you pause and consider your situation. That's kind of what I get out of this. So, If there are unrealized and realized losses. I, I, I wanted to ask one more thing that came up in, in, in my mind.[00:12:00]
Um, a lot of physicians, especially, uh, younger physicians, they're mostly investing in their accounts at work. Can you do anything with tax loss harvesting in your 4 0 1 kss or your IRAs or anything like that?
Kyle: You can't, and that's because those accounts are tax qualified. So any gains or losses realized, In those accounts is not taxable.
So this strategy only works in a taxable investment such as a taxable brokerage account.
Nate: That makes sense. Okay, so this I, I'm imagining a mid-career physician who has been investing, you know, anywhere from a few hundred to a few thousand dollars into a taxable account every month. For several years. And the market cycles, you know, it's, the market goes up and down, you know, every five years on average.
So every five years or so, there should be a reasonable, [00:13:00] uh, chunk of that taxable account that could be harvested for losses. And if they haven't done that yet, Then, uh, or let's say in the last 10 years, there's been a couple opportunities, but not many. A lot of times. You know, something that I, I always remind folks of is you actually have to have a loss to harvest a loss.
Like they wanna do this cool tax thing, but the idea of like, maybe in this last year there, there's been, you know, a, a a, a dip, but before that there it was mostly up. Which is great. Everybody wants their investments to go up, but, um, that just means that this little tax strategy isn't available to them.
But when the market goes up, and that means we have a gain on our hands. Right. The opposite of a loss. Can you explain, uh, I it's, it may be obvious, but if you have a gain, how do you realize a gain, much like how do you [00:14:00] realize a loss.
Kyle: Yeah, it, the unrealized and realized concept applies to a gain as well.
So again, if you buy a mutual fund, uh, you know, yesterday and it's up in value today, it's, it's appreciated. It's increased in value and, uh, You haven't done anything with it still sitting in your portfolio, then that's an unrealized gain. You haven't, you haven't realized that gain yet. You know it's, you haven't sold it.
Mm-hmm. But as soon as you sell that position with a gain and, and you sell those shares off, then you've just realized that gain and uh, I see that gain would be then reported on your taxes.
Nate: Okay. Reported on your taxes. So I, I'm, I'm going somewhere with this. So I'm imagining a situation where a mid-career physician has a reasonable amount of bonds in their portfolio and a probably a whole bunch of equities in their portfolio.
And they come to you and they want [00:15:00] to harvest their losses and let's say they wanna harvest their losses and their bonds. You know, bonds have kind of taken a dip this year and they say, Hey, I wanna harvest these losses. And you look over it and you see that they do have a loss in their bonds, but they have a big gain in their equities.
So imagine a pretty large portfolio and they have, you know, $50,000 loss in their bonds and a. T uh, $20,000 gain in their equities. I th there's an opportunity here with kind of netting these gains and these losses, and I wanted you to break that down for everybody. Yeah.
Kyle: So it's tracked throughout the year, so, um, for your tax year, and it's mm-hmm.
Uh, reported on a tax document to you at the end of the year by your custodian, and it basically collates. Uh, all the gains you realized, all the losses you realized, and it just nets those against each other, and that gives you the [00:16:00] net gain loss for the year. And so in the scenario you laid out with the $50,000 bond loss and the $20,000 equity gain, if you were to liquidate both positions to sell every share of both of those, Investments, you would realize a $50,000 loss in the bonds and a $20,000 gain in the equities and your end result at the end of the year, if you place no more trades for gains or losses.
Mm-hmm. You would have a net $30,000 loss is what
Nate: you would've realized. And you can carry that forward, like we talked about before.
Kyle: Right. Yeah. Not loss of them carry forward.
Nate: Mm-hmm. Mm-hmm. So you have effectively raised your basis. Which I know we're now, we're, I'm getting into the weeds a bit, but you raise your basis on that equity side because assuming you buy back in eventually, but then you get the tax break for $30,000, that's 10 years of carry forward on the bond side.
Kyle: Yeah, [00:17:00] and usually netting, netting is one of those things too that, um, is helpful when you're cleaning up an old portfolio. You know, when you're, you wanna sell as much of these positions as you want, whether they have a gain or a loss, uh, then that's when those losses are crucial. 'cause you can use those to liquidate a bunch of positions with lots of gains and, and actually try to net a zero tax bill, which is a strategy used for Yes.
Kind of massive rebalancing, but that's a subject for another day.
Nate: Yeah. Well that's actually a, a good point. Um, so I'll try to keep it high level, but to, to, to say what you just said again. So what you're saying is, let's, let's say you come to, um, or you get some advice about your portfolio and you find out that you're not in your favorite fund, like you would, if you could do it all over again, you would've chose a different fund.
And, um, you know, if you're being. Conscious about this. You're making good decisions. You wouldn't just liquidate a big and and cause yourself a huge tax bill. [00:18:00] While you're making it a ton of money because you're gonna, the taxable iss gonna be pretty brutal. But if that portfolio, um, goes down and you have a loss, while it feels it's painful to sell at a loss, you realize this is the perfect time to get into the, into the position or the, the mutual fund that you like.
And get this tax break to boot, right, because mm-hmm. Then you can, instead of paying to get out of this portfolio you don't like, you get sort of to save, to get out of this portfolio you don't, that you like, and that wash sale that you talked about doesn't really apply 'cause you'd be buying into something totally different.
Right. Um, so explain that again, just so if people are in a portfolio that they think they, they may or may not like, um, And they're worried about the wash sale. Why? What, what do you do if you don't wanna leave your money in cash? What would you do when you sell a position you don't like and, and buy into something else?
Why does that work?
Kyle: Yeah. 'cause the language around the [00:19:00] wash sale is, it's, it's fairly relaxed. It says you cannot invest into a fund that is materially the same. Mm-hmm. It has to be a fund that's materially different. So, You know, uh, the best example would be like an all US stock fund. If you sell an all US stock fund and then turn around and buy another All US Stock fund, even if it's with a different mutual fund company.
Say you sell Vanguard's all US stock fund, you turn around and buy Fidelity's all US stock fund. Mm-hmm. The, uh, powers to be would consider that a wash sell. You know, you, those funds are materially the same, you know? Um, So you have to be careful with that. So, um, you need to ask yourself that question, you know, what am I selling?
And then what do I plan to buy? And is that gonna run up against them being ma you know, do, can I make an argument that they're materially the same or materially different? And depending on what your answer is to that, that [00:20:00] tells you whether you can buy that next fund within 30 days or not. Right. Um,
Nate: Yeah.
Okay. Yeah, that makes sense. And the, the idea would be that if you're in a fund you don't, like, you are hopefully gonna buy something materially different. So I'm imagining something like a a, a. Extreme scenario where someone puts all their money in a single stock and they realize, wow, that's really risky.
And so they decide to sell it at a loss and take, take the, you know, the tax break, uh, for as many years as they possibly can. And then they buy into an index fund. And the i r s would look at that and say, these are materially different. So you got the tax break, you got to buy right back into the thing that you like.
And, um, makes sense for you and your retirement plan and your, your sort of risk tolerance for you and for, you know, for your goal. And then you, you have no tax problems at all. Um, and then on top of [00:21:00] that, if you happen to have the gain somewhere else, you take advantage of this opportunity to, uh, bring that or essentially sell at the gain.
Sell the gain, sell the loss net. The difference. And then take the carry forward, uh, tax loss harvesting as far as you can. That's right. Yeah. I think that's about the extent of the strategy, right.
Kyle: Yeah, I think what you're trying to, what we're trying to paint here is this pitfall of, uh, just being so focused on harvesting the losses for tax loss harvesting.
Mm-hmm. And not thinking about how those losses can fit into the bigger picture of rebalancing your whole portfolio. So if you have work to do on your portfolio to get some things to move around, then just use those losses to. To sell as much of the gains as you can to get things, you know, resituated and we're about tax loss harvesting down the road once your portfolio has been rebuilt and reconstructed.
But if your portfolio is already in, you know, swimming shape and you, you love this portfolio and it just [00:22:00] happens to be a downtime in, in the market for some of the purchases you've made. And you look at those unrealized losses and you see that there's, you know, a, a good chunk of losses that you could realize if you were to sell those shares, um, then that's a perfect opportunity to do some tax loss harvesting.
Mm-hmm. Uh, but again, uh, you kind of paint yourself in that corner again and what would I do with my cash? Do I leave it there for 30 days and then buy it back into my favorite fund? Or do I use that cash and buy a materially different fund? But, Do, does this materially different fund that's new? Do I try to work it into my portfolio and make it part of my long-term strategy or is this something that I'm now gonna have to figure out what to do with, uh, you know, after the 30 days?
You know, do I sell it? Do I continue to hold it? Yeah. Do you have to make a decision about that fund at some point?
Nate: Oddly enough, the toughest thing that can happen is you buy into a different [00:23:00] fund. That isn't your favorite while you're waiting for 30 days. And if that fund goes up, then you're sort of stuck with it unless you wanna pay a tax bill to sell it again and buy back into your favorite fund.
So it, I think, I think that it just presents, uh, strategic challenges. Not to say that it's not worth it, um, but. What this can, because of these challenges, it can get sort of confusing. Like there isn't a clear rule on when and you should or when you shouldn't do this. So for the listeners, can you, like, what is the big takeaway for tax loss harvesting?
That's like, I know we can't draw a line in the sand really, but um. If they're looking at their portfolio and just trying to decide, should I do this or should I get help with this? Like, is there now the right time? Kind of what's the big takeaway for them to decide whether or not to take action?
Kyle: The big takeaway is if, if you're able to realize a large [00:24:00] enough loss that could give you multiple years of deductions to carry forward, then as a physician who pays more than their fair share of taxes, tax loss, harvesting is a
Nate: no-brainer.
I agree, no brainer. Big enough loss, no brainer. So that's all for today. Until next time, remember, you're not just making a living. You're making a life.
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