Tax-Loss Harvesting Is a Year-Round Job

Last Updated Dec 2, 2009 11:28 AM EST

There's an old saying that "there's a time for everything and a season for every activity." While this may be true for activities like harvesting crops, it's not true of harvesting losses for tax purposes. Tax management is a year-round job. Far too many investors and advisors wait until year-end to check for opportunities to harvest losses. Portfolios should be checked throughout the year.

A loss should be harvested whenever the value of a tax deduction significantly exceeds the transactions cost of the trades required to harvest the loss, immediately reinvesting the proceeds in a manner avoiding the wash sale rule. 2009 provides a perfect example of why waiting until the end of the year is a mistake. Losses that could have been harvested in March before the rally began have now become gains in many cases, meaning they can't be harvested.

Short-Term Losses Vs. Long-Term Losses It's also important to realize any short-term losses before they become long term. Short-term losses are first deducted against short-term gains that would otherwise be taxed at higher ordinary income tax rates. Long-term losses are first deducted against long-term gains that would otherwise be taxed at the lower capital gains rate.

For example, before any loss harvesting, imagine a taxpayer has realized short- and long-term gains and unrealized short-term losses. These losses can be harvested, reducing the short-term gain that would have otherwise been taxed at higher ordinary tax rates. If not harvested until they became long-term losses, they would reduce long-term gains that would have been taxed at the lower long-term capital gains rate.

Investors should be checking their portfolios throughout the year for such opportunities. And if you're working with an investment advisor who takes most of the year off when it comes to tax management, perhaps it's time to find another advisor.

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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