Tax Loss Harvesting â€“ using sector ETFs to continue the exposure
Talking about underwater positions is never fun as the end of the year approaches but realizing losses has a â€œsilver lining,â€ said Rande Spiegelman, vice president of financial planning at the Schwab Center for Financial Research, in a conference call with reporters Friday.
â€œThe good news is losses can be used to lessen the tax bill and position for next year,â€ he said.
Realized losses can be deducted from ordinary income by up to $3,000 a year, while any additional losses can be used in future years.
However, investors need to be aware of the â€œwash-saleâ€ rule. Investors cannot claim the loss if they buy a â€œsubstantially identicalâ€ security within 30 days of the sale.
This is where ETFs can help out if investors want to keep exposure to the market.
For example, an investor may be sitting on a loss this year on a financial stock, explained Michael Iachini, managing director of ETF Research at Charles Schwab Investment Advisory. The investor can sell the stock and take the loss, but they might miss any rebound rally in the financial sector over the next month.
To maintain exposure to the sector, the investor could buy an ETF indexed to financial or bank stocks, Iachini said on Fridayâ€™s call. ETFs are a â€œgood fitâ€ for the strategy if investors donâ€™t want to be out of the market for a month.
Some financial advisors use tax-loss harvesting strategies featuring ETFs that track the same sector but are pegged to different indexes.
The IRS hasnâ€™t provided a hard definition of â€œsubstantially identical,â€ and investors should consult a tax advisor about the wash-sale rule.
Also, investors need to consider any ETF commissions or other trading costs associated with the strategy.
Finally, Schwabâ€™s Spiegelman said not to lose sight of the overall investment plan and let the â€œtax tailâ€ wag the dog. â€œDonâ€™t upset the long-term investment plan or asset allocation just to get a tax break,â€ he said.
â€œETFs have made tax loss harvesting a lot simpler than it used to be,â€ said Charles Zhang of Zhang Financial in a recent Reuters report. â€œItâ€™s not that hard to find one thatâ€™s a good stand-in.â€
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