Most people invest to grow their money, not to lose it. But in the right circumstances, realizing an investment loss can be a smart tax move. In this video, Joe Clagg of Topel Forman Wealth Management walks through three strategies investors can use to generate losses and why doing so can lead to a better after-tax outcome.
Tax-loss harvesting: the silver lining of a down market
Tax-loss harvesting is a reactive strategy. When a holding drops below what you paid for it, you can sell it, realize the loss, and carry that loss forward to offset future capital gains. This gives you more flexibility later when you rebalance, take a distribution, or exit a position you no longer want to hold.
The catch is the IRS wash sale rule, which disallows the loss if you buy the same or a substantially identical security within 30 days. Rather than sitting in cash and risking a missed rebound, Joe explains how investors can move into a similar but not identical investment to stay in the market while the waiting period passes.
Direct indexing: a proactive approach
Direct indexing starts with the goal of generating losses. It is often used by investors who hold highly appreciated positions they'd like to diversify away from but can't sell without a large tax bill. Money is invested in a targeted part of the market and monitored closely. If that segment declines, the position is sold and replaced with a similar holding, and the process can repeat, building up losses that can offset gains elsewhere in the portfolio. There are no guarantees. If the market segment rises, there are no losses to harvest, so this strategy requires patience and a clear plan.
Long-short strategies: rare, but worth knowing about
A long-short strategy holds long and short positions at the same time, which can create more opportunities to harvest losses. It also brings significantly higher risk and complexity, a multi-year commitment, and a difficult exit. It isn't appropriate for most investors, but in the right situation it can make sense.
The bottom line
The goal isn't to create losses. It's to create a better after-tax outcome. Each of these strategies depends on your full financial and tax picture, so they work best when your advisor and your CPA are coordinating.
Have questions about whether any of these strategies fit your situation? Contact us today.