A Portfolio Project: Turning Lemons into Lemonade
Opportunities for Tax-Loss Harvesting
Last Updated: April 1, 2020
Stock market declines can cause investors to feel anxious, as they wonder if the drop will ever end. But that feeling is an ill wind that blows no good. Stock market declines can present unlikely opportunities to enhance after-tax returns. In the current stock market environment, we are reviewing our clients’ portfolios and looking for ways we can “turn lemons into lemonade.”
One of the techniques we use is tax-loss harvesting, which is the practice of selling a security that has experienced a loss. By realizing, or "harvesting" a loss, we can offset taxes on realized gains and income in a client’s portfolio. Candidates for tax losses could be legacy stocks or mutual funds that were part of a client’s portfolio when they first began working with Segall Bryant & Hamill. These holdings may have been disappointing of late, possibly because the investment thesis does not seem to be playing out, or because the stock or its sector may be temporarily out of favor. Another possibility, currently the case with many stocks, is that the stock has suffered as part of the broad-based sell-off due to market conditions. When we decide to harvest losses – determining whether to re-invest in the same holding, buy a new holding, or refocus the portfolio on our highest conviction ideas – the decision is based on our proprietary, fundamental research process.
Of course, no one likes to take a loss, so why is this beneficial for clients? How is this turning lemons into lemonade?
Using tax-losses in future years. U.S. tax code allows investors to carry forward unused realized losses into future years. For example, in future years, we may want to consider recognizing a gain in a holding that has become a relatively large weight in a portfolio due to its price appreciation. The cost of diversifying away this risk can be mitigated if the gain can be offset against a loss, either a current one or one from the carry-forward bank. There are also non-portfolio reasons that could drive this decision such as the need to raise cash for a major expenditure. Further, if capital gains tax rates are raised in future years, these carry-forward losses become even more valuable.
Consider that in a year in which there are no realized capital gains, clients can deduct up to $3,000 from a previous year’s carry-forward losses against their adjusted gross income (AGI), ultimately lowering their tax bill.
Repositioning portfolios. Tax-loss harvesting allows our portfolio managers and clients to reposition portfolios to favor stocks or funds better reflecting the highest conviction ideas of our equity research teams. If we think a holding is still worthy of being retained, we can accomplish tax-loss harvesting by doubling the size of the holding, waiting 31 days, and then selling the shares originally purchased. (The 31-day wait is required to avoid a “wash sale,” which essentially would disallow recognition of the loss until the position is fully sold.) The process also can work in reverse: selling first, then waiting 31 days, and repurchasing the security. In either event, the client retains the economic merits of the holding and the benefit of currently recognizing a loss.
While stock market corrections are an unavoidable component of long-term investing, we believe they can be a key opportunity for clients to reap better after-tax rewards over time and make lemonade out of lemons. If you would like to discuss this relative to your investment portfolio, please reach out to your portfolio manager or call us at (800) 836-4265.
This information has been prepared solely for informational purposes and is not intended to provide and should not be relied upon for accounting, legal, tax, or investment advice. The factual statements herein have been taken from sources we believe to be reliable, but such statements are made without any representation as to accuracy or completeness. Opinions expressed are current opinions as of 12/31/19. These materials are subject to change, completion, or amendment from time to time without notice, and Segall Bryant & Hamill is not under any obligation to keep you advised of such changes. This document and its contents are proprietary to Segall Bryant & Hamill, and no part of this document or its subject matter should be reproduced, disseminated, or disclosed without the written consent of Segall Bryant & Hamill L.L.C. Any unauthorized use is prohibited.