Aaron Katsman 58.
(photo credit: Courtesy)
With the end of the year in sight, now may be a good time to adjust your investment portfolio. After the recent surge in global equity markets, there is a good chance you are sitting on some nice capital gains. If you take your profits, you may be subject to paying capital-gains tax.
As the old saying goes, there are only two certainties in life: death and taxes. While I have no solution regarding the death issue, there are ways to make your portfolio more tax efficient.
While you may have nice profits from recent trades, chances are you still have positions that have yet to recover fully from the market crash of two years ago. Unfortunately, when I advise clients to sell unprofitable stocks for the loss to be used to offset other gains within the portfolio, they often refuse. Investors sometime prefer to hold off selling stocks that have dropped, believing they will eventually go back up.
However, there are two problems with this assumption. First of all, as the stock hasn’t been a stellar performer until this point, why should the investor think it should start going up? Secondly, there may be another way to profit from a poorly performing stock.Tax-loss selling
There is a term used for selling positions at a loss in your portfolio: tax-loss selling. It’s a process of selling securities at a loss to offset a capital-gains tax liability. Though you may not realize it, tax-loss selling may be the most important way to reduce your tax bill. If done correctly, it can save you money and help diversify your portfolio in ways that have not yet been considered.
For example, let’s say you have a gain in Teva stock and decide to sell it; you will be taxed on that gain in full. But if you have a loss in Microsoft and sell the stock, the amount of the loss may offset the gain in Teva, reducing the sum of the taxes owed. Although you may not be able to recover your entire loss, it certainly cushions the blow.Why wait?
It’s customary for professional money managers and investment advisers to wait until the end of the year to start selling their losing stocks. But there are no hard and fast rules to this. Personally, I like to take advantage of downturns in the market, to review clients’ portfolios and advise them on taking losses.
Keep in mind one of the golden rules of investing: ride your winners. Some of the most successful investment strategies call for investors to hold onto their best performing stocks and sell the laggards, because chances are there is a good reason why they are lagging.
As explained above, the added value in selling the laggards is that the losses can be used to offset any possible gains. Not only does this update the portfolio by holding only the good positions, but realizing the losses is also a significant benefit.Be careful
There is a rule in the United States known as the Wash-Sale Rule,
according to which the IRS disallows a loss deduction from the sale of a
security if a “substantially identical security” was purchased within
30 days before or after the sale. For example, if an investor sold 100
shares of Pfizer on March 1 and then bought back 100 shares of the same
stock on March 15, the loss deduction would not be allowed. The
Wash-Sale Rule is designed to prevent investors from making trades for
the sole purpose of avoiding taxes.Talk to an accountant
important to speak with your accountant before implementing this
tax-loss strategy. This brief article is simply meant to alert you to
the concept of the Wash- Sale Rule, but it is certainly not a complete
discussion of all the aspects of it, and it should not be considered
individual tax advice. Many times, your accountant will work closely
with your investment adviser to best serve your needs. The accountant
will also be knowledgeable about any local tax implications that have
not been addressed in this article but are important to understand as
Katsman is a licensed financial adviser in Israel and the United States
who helps people open investment accounts in the US.