Tax Loss Harvesting and Portfolio Restructuring during a Crash.
Let’s imagine Mrs. Thompson, an executive at a large tech company. Mrs. Thompson has accumulated stocks of her employer through the most advantageous stock purchase plan that has been offered over the years. Her adviser, who separately manages a well diversified portfolio has warned her that accumulating stocks of the very company she gets her paycheck from was a potentially dangerous doubling up of risk. She had been looking for a way to trim that single stock account but since she has had to hold these stocks until they vest she was until recently exposed to large capital gains on these positions.
Well, her company stock has now dropped dramatically and that capital gain has reduced. This is a good opportunity to realize this now smaller capital gain. Furthermore, Mrs Thompson could find some stocks in the portfolio her advisor manages to generate capital losses that would completely offset the gains on her company stock. Effectively Mrs Thompson is restructuring her long term overall portfolio toward a less risky one and doing so for little or no tax cost. Opportunity in the middle of a storm.
Perhaps you think that it is not a good idea to sell stocks when they are way down. But Mrs Thompson does not have to do any net sale of stock. She can sell stocks and simultaneously purchase other stocks. Her stock exposure may change in nature but her exposure to the stock market at large may remain the exact same in the process.
Because this effectively lowers your taxes, the IRS has rules that frame what they allow about this practise. These are called section 1091 wash sales rules and they force the investor not to purchase any security “substantially identical” to the ones she just sold for a period of 30 days. I want to emphasize here that if the portfolio managed by the advisor is fully diversified it becomes easy to offset the gains of Mrs Thompson by selling parts of that diversified portfolio, and immediately reinvesting. This may result in her portfolio being momentarily (for 31 days) a bit different from what it should be, but to be invested in a slightly different portfolio for a period of 30 days is usually a tiny price to pay to get the tax benefit for the current fiscal year. Here is an article providing you with more details. Remember that harvesting tax losses and doing so as early as you can, effectively increases the after tax return of your investments.
The general idea is to be vigilant about harvesting tax losses, and large market downfalls usually present a major opportunity to do so. Make sure that in the process your overall set of assets gets shifted to a portfolio that has precisely the volatility you can tolerate in the long run.
Be safe, be cool, be like Mrs Thompson,
Marc
