Making Lemonade from Lemons (An Oldie But Goodie)

August 25, 2015  |  

Making Lemonade from Lemons (An Oldie But Goodie)

Key Takeaways
• Don’t let taxes drive investment decisions
• Every portfolio experiences losses at one time or another. Use those losses to your advantage
• Be mindful of the timing of trades especially in light of the wash sale rules

We often talk, especially towards year end, about loss harvesting or harvesting your losses, but we use this technique throughout the year to save taxes. While no one likes losses in his or her portfolio, this technique is the equivalent of making lemonade from lemons. Though tax considerations shouldn’t be the primary driver of your investing decisions, losses will occur in every portfolio at one time or another and utilizing those losses can add significant benefits to the portfolio’s after-tax return over time.

How it Works

Let’s say you sold ABC fund this year for $2,500 more than you paid when you bought it four years ago. You also decide to sell XYZ fund that you bought six years ago at a loss of $7,000. You may offset your $2,500 capital gain from ABC fund with the loss from XYZ fund and no tax is due. You are left with a net loss of $4,500 ($7,000 loss less $2,500 gain). In addition to sheltering the gain with the loss, you can offset up to $3,000 of ordinary income tax this year with the loss. Any unused loss can be carried forward indefinitely to be used in future tax years. In our example, the loss carryforward would be $1,500 ($7,000 loss less $2,500 gain less $3,000 ordinary income offset = $1,500 loss carryforward.

Time any Trades Appropriately

If you’re buying a mutual fund or an ETF in a taxable account, find out when it will distribute any dividends or capital gains. Consider delaying your purchase until after that date, which often is near year-end. If you buy just before the distribution, you’ll owe taxes this year on that money, even if your own shares haven’t appreciated. And if you plan to sell a fund anyway, you may minimize taxes by selling before the distribution date.

If you’re selling to harvest losses in a mutual fund and intend to repurchase the same security, make sure you wait at least 31 days before buying it again. Otherwise, the trade is considered a “wash sale,” and the tax loss will be disallowed. If you have unrealized losses that you want to capture but still wish to maintain exposure in that asset class, buy a similar fund that invests in the same asset class. You will end up with the same asset allocation, but you would have captured the tax loss. We utilized this technique during the significant market decline in 2008 and early 2009. We were able to harvest significant losses in client portfolios that went on to shelter gains in the years that followed.

Tax planning is a cornerstone of the wealth management process. By working with your tax professional and your wealth manager, you can maximize your after-tax return with loss harvesting. Please feel free to contact me if you would like more information on this or any other wealth management topic. You may also call the office phone number at 610-695-8070 or visit us online at

About Mark Rioboli, CFP®, CFS

Mark A. Rioboli, CFP®, CFS is Director of Wealth Management for Independence Advisors, bringing over 30 years of experience in the wealth management industry. Have a question for Mark? CLICK HERE TO ASK MARK
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