Looking to pursue an optimal, tax-efficient portfolio balance? Consider tax-loss harvesting. It’s a process designed to take advantage of an IRS rule allowing realized losses to offset the realized gains on in your taxable portfolio. This process may potentially lower your tax liability, on the condition that all the trades are closed out in the same calendar year.
Think of tax-loss harvesting as you would the annual grain harvest. For farmers, harvest is a time to reap the rewards of their labor and plan next year’s crop allocation. It used to be quite laborious, but today’s harvesters, equipped with the latest diagnostics technology (plus Wi-Fi and air conditioning), can automate the process and help farmers harvest more efficiently.
Tax-Loss Harvesting: Concept in a Nutshell
To illustrate, consider two investors, Investor A and Investor B:
- Purchases 1000 shares of ABCD stock at $10/share on the first trading day of the year.Purchases 1000 shares of XYZ stock at $10/share on the first trading day of the year.Sells ABCD for $11/share on the last trading day of the same year.Holds XYZ stock which closes the year at $9/share.
In this scenario, Investor A has a $1000 profit on his ABCD trade which will be subject to capital gains tax.
- Purchases 1000 shares of ABCD stock at $10/share on the first trading day of the year.Purchases 1000 shares of XYZ stock at $10/share on the first trading day of the year.Sells ABCD for $11/share on the last trading day of the same year.Sells XYZ for $9/share on the last trading day of the same year.
In this scenario, though Investor B has the same $1000 profit that Investor A does, because he sold XYZ before the end of the year, the $1000 loss on the stock is considered “realized,” and may be used to offset ABCD’s gains – potentially eliminating any capital gains tax.
TD Ameritrade clients who have taxable accounts invested in TD Ameritrade Investment Management’s Essential Portfolios and Selective Portfolios investing in ETFs can enroll in an automated tax-loss harvesting program at no additional cost. The portfolio is monitored daily, and when an opportunity is identified, the position will automatically be sold and the proceeds invested into a replacement security designed to maintain the portfolio’s target allocation.
When you choose to enroll in our tax-loss harvesting service, TD Ameritrade Investment Management reviews your portfolio on a daily basis to look for tax-loss harvesting opportunities, which means you can realize losses throughout the year that might not necessarily be available at year-end. This may further help you to offset capital gains.
If you don’t have any capital gains or if you have more losses than gains, you can use the losses to offset up to $3,000 of other taxable income per year. After using your losses to offset capital gains and income, you can use any remaining losses to offset gains or income in later years (under current tax laws).
The service is also designed in a way to avoid running afoul of the IRS’s “wash sale” rule. A wash sale is when a security (or option) is sold at a loss and then it, (or a substantially similar security) is bought back within 30 days. In this case, the loss on the initial sale is disallowed and cannot be used to offset realized gains. One caveat—in general, tax-loss harvesting programs are designed to prevent you from violating the wash sale rule, but the IRS can still invoke it if your spouse or a company you control buys back a similar position within 30 days.
Tax-Loss Harvesting for Portfolio TLC
Despite the obvious benefit of reducing your tax liabilities, there are a couple other potential advantages to tax-loss harvesting. Just as the farmer—who has a limited amount of resources in the form of land—needs to make sure he or she allocates it properly to the crops that are performing optimally, an investor should consider culling unfavorable positions in a portfolio to potentially free up resources for optimal allocation.
Strategic tax-loss harvesting can help to make your portfolio more efficient and improve your after-tax returns. Just remember, as with any tax-related questions, it’s best to talk to your tax professional, who can advise you on what’s best for your specific tax situation.
How To Enroll
Qualified clients will have the ability to enroll via the Portfolios App Store for iOS devices, Android Phone, or by contacting a TD Ameritrade Investment Management Portfolios Specialist.
Once enrolled, TD Ameritrade Investment Management manages the process so you don’t have to. At any point, you can turn off the feature if you no longer desire it.
For more information about TD Ameritrade Investment Management’s tax-loss harvesting service, contact a Portfolios Specialist at 800-665-1978.
Other Key Considerations
TDAIM goes through a rigorous due diligence process to select securities to replace those sold for tax-loss harvesting purposes. TDAIM seeks replacement securities that meet TDAIM’s high standards and keep your portfolio in line with its target allocation.
Before investing carefully consider the underlying funds’ objectives, risks, charges, and expenses. For a prospectus containing this and other important information about each fund, contact us at 888-310-7921. Please read the prospectus carefully before investing.
All investments involve risk, including loss of principal. Past performance does not guarantee future results. There is no assurance that the investment process will consistently lead to successful investing. Asset allocation and diversification do not eliminate the risk of experiencing investment losses.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities.
TD Ameritrade Investment Management (“TDAIM”) does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances as to whether the TDAIM tax-loss harvesting feature is appropriate for you. This feature generally would be more beneficial to investors in higher tax brackets and high-tax states.
The tax-loss harvesting feature is currently only available with the TDAIM ETF-based portfolios in taxable TD Ameritrade Investing Accounts. Tax-loss harvesting is not appropriate for all investors. Investing in securities involves risk of loss that the client should be prepared to bear. TDAIM does not represent or guarantee that the objectives of the tax-loss harvesting feature will be met. The performance of the replacement securities purchased through the TDAIM tax-loss harvesting feature may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes. TDAIM only reviews each account that is managed by it individually to help ensure that your account does not violate the “wash sale” rule. When you enroll in the tax-loss harvesting feature, the enrollment is on an account basis and does not apply to other TDAIM portfolios you may have. Each eligible TDAIM portfolio must be enrolled separately in the TLH feature. Accordingly, you are responsible for monitoring your brokerage accounts and your spouse’s brokerage accounts at TD Ameritrade or elsewhere to ensure that transactions in the same security or a substantially similar security do not create a wash sale. The wash sale rule postpones losses on a sale, if replacement shares are bought around the same time.
Prior to enrolling in the tax-loss harvesting feature, please read TDAIM’s white paper.
Advisory services are provided by TD Ameritrade Investment Management, LLC (“TD Ameritrade Investment Management”), a registered investment advisor. Brokerage services provided by TD Ameritrade, Inc. TD Ameritrade Investment Management provides discretionary advisory services for a fee. Risks applicable to any portfolio are those associated with its underlying securities. For more information, please see the Disclosure Brochure (Form ADV Part 2A).