What is Tax Loss Harvesting?

Tax loss harvesting is a strategy where you sell investments that have lost value to offset gains in other areas of your portfolio, thereby reducing your taxable income. This tactic applies to taxable accounts, not tax-sheltered ones like 401(k)s or IRAs.

How Does It Work?

Here’s a simple illustration:

• Scenario: You bought Tesla stock and it soared, but you also bought Bed Bath & Beyond stock, which plummeted.
• Outcome: You lost $10,000 on Bed Bath & Beyond but gained $10,000 on Tesla.
• Result: By selling the Bed Bath & Beyond stock, you can offset the gain on your Tesla stock, resulting in zero taxes on your Tesla gain.

If your losses exceed your gains, you can deduct up to $3,000 off your ordinary income annually. Any losses beyond this can be carried forward to future years, potentially giving you ongoing tax relief.

Strategic Use of Tax Loss Harvesting

For high-income law firm owners, this strategy can be particularly beneficial. By strategically using tax loss harvesting, you can enjoy significant savings during high-income years. This process allows you to turn what may initially seem like a financial setback into a tax-efficient opportunity.

Real-Life Examples of Tax Loss Harvesting

Example 1: The Rise and Fall of BlackBerry

• A client held onto BlackBerry stocks, which soared during the tech boom only to plummet later.
• The client also had a large taxable brokerage account. By using BlackBerry’s losses to offset gains in other investments, the client was able to make necessary adjustments without facing hefty taxes.

Example 2: Concentrated Wealth in Mega-Cap Stocks

• Another client had significant unrealized gains in stocks like Apple and Nvidia.
• To avoid future tax complications, the client used losses from other parts of the portfolio to offset some of these gains. This not only reduced the tax impact but also diversified the client’s investments.

Steps to Implement Tax Loss Harvesting

1. Review Your Portfolio: Identify investments in taxable accounts with unrealized losses.
2. Sell the Investment: Realize the losses by selling underperforming assets.
3. Reinvest Strategically: Reinvest in similar but not identical investments to maintain your portfolio’s balance.
4. Timing is Key: Be mindful of the wash sale rule, which disallows repurchasing the same or substantially identical investment within 30 days.

Timing and Ongoing Monitoring

Tax loss harvesting is not just an end-of-year task. Regularly review your portfolio throughout the year. If an investment drops significantly, it might be wise to sell mid-year and realize the loss. This continuous monitoring ensures you’re always ready to harness potential tax savings when opportunities arise.

Why You Should Consider Tax Loss Harvesting

It’s often the small, smart financial maneuvers that add up to substantial savings. Tax loss harvesting can have a profound impact on your immediate tax situation and future financial health. While it may seem like a minor aspect of tax planning, its cumulative effect can be significant.

Wrap Up

Tax loss harvesting is a formidable strategy that should be a staple in your financial planning toolkit. By staying proactive and working with a knowledgeable financial advisor, you can ensure this strategy aligns perfectly with your overall financial goals.

Resources:

• Schedule a Call with Darren
• Wurz Financial Services
• The Lawyer Millionaire: The Complete Guide for Attorneys on Maximizing Wealth, Minimizing Taxes, and Retiring with Confidence by Darren Wurz
• LinkedIn: Darren P. Wurz
• The Lawyer Millionaire Podcast and Book Club
  To connect with podcast guests and other law firm owners, discuss these topics further, and access our quarterly book club, join our LinkedIn Podcast and Book Club

Transcript:

Darren Wurz [00:00:00]:
Did you know that one of your losing investments could actually save you thousands in taxes this year? Welcome to the Lawyer Millionaire where we deliver financial planning insights and business strategy for ambitious law firm owners so you can enjoy more time, more abundance and less stress, even if you’re still growing your law practice. Here’s the scenario. You’ve got some underperforming stocks sitting in your investment portfolio and every time you look at them, you cringe. What if I told you that those losses could actually be one of your smartest tax saving moves? In today’s episode, we’re diving into tax loss harvesting. Woohoo. A simple strategy that can save you big on taxes while keeping your financial plan on track.

Intro [00:00:51]:
We are on a mission to help lawyers and law firm owners maximize wealth and achieve financial independence. Welcome to the Lawyer Millionaire with Darren Wurz from Wurz Financial Services.

Darren Wurz [00:01:05]:
First, let’s define tax loss harvesting. What is it? This is the process of selling investments at a loss to offset gains in your portfolio, in other holdings or even reduce your taxable income. This strategy applies specifically to taxable accounts. So if you’re thinking about your 401(k) or IRA, this isn’t going to be the right tool for that. But here’s how it works. Losses from one investment can offset gains in another. Let’s say you bought a stock and it’s done great. You bought Tesla, it has soared through the roof.

Darren Wurz [00:01:39]:
Or and then on the other hand, you bought Bed, Bath and Beyond and it has just plummeted. You lost 10,000 on Bed Bath & Beyond, you gained 10,000 in your Tesla stock. If you sell the Bed Bath & Beyond stock, you can take that loss, use it to offset the gain on the Tesla stock. Fantastic. And then you won’t owe any taxes on the gain in the Tesla stock. Now, if your losses exceed your gains, you can deduct up to $3,000 off of your ordinary income annually. And if your losses go even beyond that, you can take the leftover amount and carry it forward into future years. So it really behooves you to take your losses to harvest, harvest the losses, you know, even if you don’t think you’re going to use them, it’s just a, it’s a, it’s a tax savings just sitting there waiting for you to use it.

Darren Wurz [00:02:35]:
Right? And this can be very, very helpful. If you are a law firm owner and you have fluctuating income, you can use tax loss harvesting strategically to give you some savings in some of those high income years. And you know what, what’s great about this. It’s not just about taxes. It’s about turning a financial setback into a smart win. All right, now, why does this matter? Well, I’ll give you two illustrations to share how impactful tax loss harvesting can be. First, anybody remember BlackBerry? And if you don’t, well, you’re very young. The BlackBerry was the iPhone.

Darren Wurz [00:03:17]:
Pre iPhone, Right. It was the thing. It was the cell phone that everybody had for business. You know, I never had one. I will admit that I’m a little bit too young. They were around. But anyway, we’re going in a different direction than we need to. But the BlackBerry, right, it was at one time the phone of choice for business.

Darren Wurz [00:03:41]:
And they kind of went by the wayside, and their stock did really, really well, of course, during the tech boom and then obviously plummeted. Well, we have a client who owns BlackBerry, and we were talking with this particular client about that particular stock. And this client also has a large brokerage account with other investments, a taxable investment account. We were talking about making some adjustments, some changes to the holdings in that investment account. But we were like, wait a minute, we got to think about taxes. Because if we make these changes, we might have some capital gains that we’ll be subject to. Because if we sell this stock over here and this fund and buy this other fund instead and make some adjustments, we might end up facing some capital gains taxes. Well, hallelujah for having BlackBerry, because here sits a bucket, a treasure trove, if you will, of tax losses that can be harvested, right? And so we could potentially use some of those tax losses to offset gains, make the adjustments that we need to make, and not have extra taxes to pay.

Darren Wurz [00:04:56]:
So there’s one example. I’ll give you another example. One particular client of ours is a very sizable investment account, taxable, most of his money in taxable investment accounts and directly in stocks like Apple. And we’re talking mega cap growth stocks like Apple, Facebook, Nvidia, household names, right? Well, here’s the problem. These stocks have built up huge unrealized gains. And so an unrealized gain is a gain you haven’t taken yet. You haven’t sold the stock yet. It’s built in, right? If you sell it, it becomes realized.

Darren Wurz [00:05:37]:
And so, you know, that could be a problem down the road because when you go to sell them, you’re all of a sudden going to have all this additional income. It’s going to affect your tax rates, it’s going to affect everything. So a smart plan would be in that type of scenario you have some concentrated wealth in some concentrated stocks to take losses from other parts of your portfolio and use those losses to offset some gains and harvest some of those gains and profits over time so you can reduce the future tax impact if you ever do decide to sell those stocks in the future. I mean, how would that work? Right? Let’s say you have five different stocks, okay? You sell a little bit of stock one, you’ve got a gain, you know, sell something else from another pile. That’s a loss offset. They gain. Buy one of your other five stocks, okay? And then kind of do that process every. Every few, you know, once a quarter or something like that and try to, you know, reduce those unrealized gains that are built in there.

Darren Wurz [00:06:42]:
Let’s break down how tax loss harvesting actually works. So here’s, here’s what you want to do, and this is a great thing to be doing and thinking about as we come in to the end of the year. And that’s why we’re talking about this. Review your portfolio. Start by identifying investments in taxable accounts that have built in unrealized losses. These are assets that have lost value since you bought them. Now, there may be other things that skew the losses or gains, like dividends or distributions, but pretty much that’s how it works. Number two, then obviously you’re going to sell the investment.

Darren Wurz [00:07:21]:
When you sell, the loss becomes realized, which means you can use it to offset gains from other investments or reduce up to $3,000 of ordinary income. Now, you may think, oh, $3,000, that’s not very much. Well, if you’re in the highest bracket, if you’re in the 37% bracket and you can reduce your income by $3,000, you end up saving over $1,000 in taxes. I mean, I don’t know about you, but I’d rather not pay an extra thousand dollars in taxes. Right? Once you’ve sold the investment, then reinvest strategically. And here’s the trick. Don’t leave that cash sitting idle. Reinvest in a similar but not identical investment to maintain your portfolio’s balance.

Darren Wurz [00:08:08]:
Okay? So the IRS says you can’t repurchase the same or a substantially identical. And that’s critical investment within 30 days. So you can’t sell Tesla and then immediately rebuy Tesla and get the tax laws, all right? You can’t sell an S P500 index fund and immediately turn around and buy an S&P 500 index fund and get the tax loss. I mean, you could, but you could claim it. But if the IRS audits you, you get in trouble, right? What you actually want to do instead is buy something that is substantially different. Similar, but different. So another stock fund that has similar characteristics, but it’s different enough, right? Has a different strategy, has a different mix of investments. If you sell Tesla, buy a large cap growth fund that has Tesla, and I don’t know why Tesla’s the stock of the day, but it is.

Darren Wurz [00:09:08]:
If you sell one large cap growth fund, buy a different large cap growth fund that is actively managed and maybe has a different investment strategy, right? Even if you don’t like it, let it sit there for 30 days, then you can go back and you can buy the original investment. But you got to wait 30 days before you go back and buy the original investment. Otherwise you get caught with a wash sale. So the IRS calls this a wash sale. It invalidates the tax deduction. And instead of getting the tax loss, they’re just going to carry that forward into your basis when you repurchase, right? So you got to wait 30 days, buy something. You don’t let your money just sit in cash. It’s time in the market, not timing the market.

Darren Wurz [00:09:56]:
You want to buy something similar, but different enough that it wouldn’t be disallowed by the irs. So great. That’s tax loss harvesting. It’s a way of taking advantage of pieces in your portfolio that maybe have not panned out. Instead of writing out a loss, you can actively put it to work for you. And here’s the thing, right? This makes a lot of sense. I’ll give you a Wall street nugget, okay? An old Wall street adage says, cut your losses or cut your losers and let your winners run, okay? And it really is a great, simple piece of wisdom in investing. And we’re not talking about the market.

Darren Wurz [00:10:42]:
We’re talking about individual stocks, right? Individual stocks that you know are just trailing the market are not doing well. Losers tend to stay losers. This is pretty much a reality. You know, a lot of folks will, you know, try to pick losers that can reclaim winner status. That’s hard to do, folks, by and large, for the most part, most of the time, losers tend to stay losers and winners tend to stay losers. Up to winners tend to stay winners. Let me get that right. Up to a point, right? So your stocks that are really going, they’re.

Darren Wurz [00:11:21]:
They’re really taken off. Yeah, they, they do attract their haters. They really do, but they tend to keep going. Now, there, there does come a time when usually the party ends, but winners tend to keep that Momentum. Think about Apple, right? It’s been a winner for a long time. There was a period of time where it struggled. Yes. So when you’re, when you’re doing this, it is kind of a way of letting, giving yourself a reason to let go of the losers in your portfolio.

Darren Wurz [00:11:56]:
Sometimes we want to hang on to the losers because we just, we believe, we believe that they’re going to come back, they’re going to make a comeback, and they can. But sometimes it can take a long time and you could be missing out on other things. I have a great story about this. My dad, right, bought a company during the tech heyday, Canadian company that creates technology, healthcare technology, and they did great. I remember him telling me the stories right when we were driving to school. I was a middle schooler at the time. I’m giving away my age. And he was telling me, the stock is going nuts, it’s going through the roof.

Darren Wurz [00:12:40]:
And it was $10 a share, $20 a share, $30 a share. And then the tech bubble burst and the stock dropped to, I don’t remember exactly a couple dollars a share. I mean, and dad, to his credit, he hung onto it and I don’t think it ever went back while he owned it to exactly where it was. I think by now it has. I mean, it’s been 24 years, right, since, since that event. For a long time it did nothing. A long time. Eventually it did make some money for him.

Darren Wurz [00:13:20]:
It made quite a bit of money, but it took decades. It took. Well, yeah, it took two decades, right? It took a while. It took a long time. And meanwhile, there were other opportunities and other stocks that he often thinks, oh, if I had only bought Microsoft or, you know, something like that. So losers tend to stay losers. Anyway, enough Wall street wisdom for the day. Let’s talk a little bit more about tax loss harvesting and timing.

Darren Wurz [00:13:56]:
So a great time of year to do this is at the end of the year because the deadline is 1231. It should be something you’re looking at before the end of the year, but also it should be something you’re looking at throughout the year. Because if you have a stock in your portfolio and it drops like a rock at some point during the year. Now granted, it may bounce, you know, and you may, you may regret selling it. I wouldn’t, I wouldn’t sell something that drops right away because there does tend to be reversion to the mean and, you know, the bounce effect. Right? But if something just, you know, it’s petering out, it’s falling in mid year that might be a good time, right, to take advantage of that. So it’s something that you should be watching for throughout the year. Okay.

Darren Wurz [00:14:45]:
It’s also something that you should be looking at in those years where you’ve had gains elsewhere. If you’re selling a profitable asset like a piece of real estate or highly appreciated stock, tax loss harvesting can reduce or maybe even eliminate those capital gains. So and it gives us a great opportunity, as I mentioned before, to get rid of the losers and diversify and rebalance and redirect into other investments. Okay, so what can you do to take advantage of tax loss harvesting? Let’s simplify this. Number one, here’s you should be doing this before the end of the year. Review your accounts. Look at your taxable accounts. Identify any securities with unrealized losses.

Darren Wurz [00:15:35]:
Consult your advisor. Number two, the strategy can be complex, especially the wash sale rule. You want to make sure you don’t run afoul of that. A financial planner can help you with that. Number three, sell strategically. Execute the sales to realize the losses and make sure that aligns with your financial plan. And number four, reinvest wisely. Use the proceeds to maintain your portfolio’s growth.

Darren Wurz [00:16:01]:
Find something similar, but substantially different. Tax loss harvesting might seem like a small thing, like I mentioned, and it something that won’t make a huge dent. But the truth is a lot of small things in tax planning can add up to huge tax savings both in the present and long term. And while you might think that you have all kinds of other things to worry about, this is something you should think about because it can have such a big impact on your taxes today and in the future. And this ties directly into the bigger picture of financial planning, which is what we do here at the Lawyer Millionaire. You know, wouldn’t it be great if someone was watching out for those upper opportunities for you so you could focus on running the business instead of things like tax loss harvesting. That’s what we do. We become the eyes and ears around your finances 247 so you can focus on the things that will drive revenue and profit in your business.

Darren Wurz [00:17:04]:
That’s what we’re here for. Schedule some time with me to review your portfolio and uncover hidden opportunities to save on taxes and maybe optimize your strategy. I’ll put the link in the show notes notes to my calendar. Schedule some time with me. Just go right down there and click on it. It’ll take you right to my calendar and together we’ll create a strategy that aligns with your goals and maximizes your financial potential. This has been the Lawyer Millionaire podcast. I’m your host, Darren Wirtz.

Darren Wurz [00:17:37]:
Thank you so much for joining me on this journey to expand your business, maximize your profits, and secure your financial future. I can’t wait to connect with you again next time. Until then, take care and keep pushing forward.

Outro [00:17:57]:
Thank you for listening to the Lawyer Millionaire. Click the Follow button below to be notified when new episodes become available. This content has been made available for informational and educational purposes only. This content is not intended to represent investing or tax advice. Always seek the advice of a qualified investment or tax advisor with any questions you may have regarding your own financial circumstances.