Elean Hello and welcome to the podcast. I’m Elean Mendoza and I’m here with Evan Shorten, the firm’s founder and principal. Evan Hello everyone. I hope you’re all doing well. I want to thank you all for tuning in and listening to the podcast. I’d like to ask if you can do us a favor. If you like the podcast or find that we provide useful information please “like” and give the podcast a positive rating on the Apple Podcast App, Spotify, or Youtube. It would really help us out a lot. With that said, let’s get started. Elean So now that we’re starting the month of September it’s a really good time to start thinking about end-of-year tax-saving opportunities. With a little over three months left in 2023, it’s a good time to start thinking about charitable donations, retirement plan contributions, and the focus of this episode – tax-loss harvesting. If you’re new to the world of investing or just getting started, let’s go ahead and define tax-loss harvesting. Evan? Evan Simply put, tax-loss harvesting is the process of selling a position at a loss to offset the gains received in another position in order to ultimately lower our total capital gains, with the intention of reducing our tax liability. What makes tax-loss harvesting a powerful strategy is that you can tax-loss harvest across asset classes. Meaning, it’s not just limited to offsetting capital gains in stocks or the stock market, rather it allows us to offset capital gains in say the sale of a home or collectible by selling a stock or an ETF that might have gone negative in your brokerage account. Additionally, tax-loss harvesting can provide you with a small reduction in income as you can offset up to $3,000 per year of income. Elean Now tax-loss harvesting seems simple, but in reality it has a few caveats. After all, anytime you deal with taxes there are always going to be rules and regulations. Evan Yes, there is no such thing a free lunch. With regards to tax-loss harvesting, the biggest thing we want to watch out for is the wash sale rule. Elean Ok, can you go deeper into the wash sale rule. Evan Let’s look at this from the view point of a long-term investor. As long-term investors we often like the individual positions we have selected for our portfolios and when we go to sell a specific position with the intention of creating a tax-loss, we often have the intention of buying back the position, especially if it’s part of our overall portfolio allocation. The wash sale rule dictates that if we sell a security at a loss and buy back the same security or a substantially identical security within 30 calendar days before or after the sale, we will not be able to take a loss on that security. In other words, we don’t have much flexibility within a total of 61 days – 30 days before, the day of the trade, and 30 days after. Elean And a lot can happen in that time. Evan Exactly, we may not be able to buy back the same security for the price we sold it at potentially leaving us with a smaller allocation than originally desired. Additionally, the wash sale rule isn’t just limited to any one specific account. It actually looks across all of your accounts. Elean So if you sell stock X in your individual account, you can’t just go and buy it in your IRA or 401k. Evan Correct. That would trigger the wash sale rule and disallow the tax-loss. Another item to pay attention to with respects to tax-loss harvesting is your ongoing cost basis. Whenever you sell positions at a loss and buy it back for less than your original purchase price, you lower the cost basis for that position over time. If that position were to rally, the lower cost basis could create a higher capital gain tax. Essentially, you’re lowering your tax liability today at the risk of increasing it tomorrow. As with anything in investing, everything is a tradeoff. Elean Ok good to know. I think that’s one of the most overlooked aspects of tax-loss harvesting. If you’re the type of investor who doesn’t hold a lot of positions, you may run out of potential tax-loss harvesting opportunities quickly and may even increase your tax liability in the future. So let’s take a look at a few examples to see how tax-loss harvesting works. Evan The most straight forward example would be simply selling a stock at a loss to offset the gain in different stock. For example, let’s say you have a technology stock and it’s rallied with the tech sector this year and so you decide to take some gains. We’ll simply say you had a $20,000 gain in your tech stock. Well, $20,000 is a big income boost that is going to create an additional tax liability. However, in our imaginary example, you have also been invested in regional bank stocks for some time now and as we know, regional stocks are significantly down this year. You sell some of your regional bank stocks that are in the red and deduct that loss from your $20,000 capital gain thus lowering your net capital gains and your tax liability. Of course there are also other less thought off examples. Let’s say you bought a home in California some time up until the mid-90’s. At this point in 2023, it’s not uncommon to have a million dollar capital gain on your home should you sell it. Now there is a $250k primary residence capital gain exemption for single filers and $500k for married couples, but even then you could easily be looking at a $500,000 capital gain which has the potential to create a significant tax liability. Fortunately, it may be possible to find losses somewhere amongst your assets to reduce that capital gain. As we mentioned earlier, tax-loss harvesting can be done across asset classes, so it may be possible to reduce your capital gains tax liability for collectibles that may have significantly appreciated as well, such as classic cars and fine art. Elean Earlier we mentioned how you can harvest capital gains tax-losses to reduce your annual income. Evan can you touch on that briefly? Evan Yes. If you have capital losses that exceed your capital gains in a given year, you can offset up to $3,000 of your ordinary income. Furthermore, if you have more than $3,000 in capital losses you can carry the losses forward into the future deducting $3,000 from your ordinary income every year until the capital loss has been completely used up. For example, let’s say you have $12,000 in capital losses this year in 2023 but realized no capital gains. You could offset $3,000 of your income this year 2023, $3,000 next year 2024, $3,000 the year after that in 2025 and so on until you have exhausted the full $12,000 capital loss. While being able to offset some of your income is nice, it’s probably not something you want to prioritize as a high-net worth individual. Ideally, you would want to reduce your short-term capital gains first as they carry the highest tax liability, followed by long-term capital gains, and lastly your income. Of course, this is not financial advice. While prioritizing short-term capital gains makes sense, it may not make the most sense to your specific financial situation. Elean As always, please consult a financial professional when looking to make changes that affect your tax situation. If you ever have any questions or want to speak with someone, please don’t hesitate to contact us. With that said, it’s now September, and there are a little over three months left to this year. Now is the time to start implementing changes to reduce your overall tax-liability. Hopefully this episode of the Paragon Podcast got you thinking about items that need to be reviewed. If you enjoyed this episode, please give us a like on the Apple podcasts app, Spotify, YouTube or wherever you consume online content. Lastly, if you’re not subscribed to the podcast, please hit the subscribe button or follow button. We thank you for taking the time to listen and we’ll see you here next time.