Tax loss harvesting for beginners: how to hold on to your investment gains!
Benjamin Franklin – “..but in this world nothing can be said to be certain, except death and taxes.”
You may have noticed over the last 18 months there has been a huge explosion in the media and everyday conversations around personal finance and investing. Only last week I was hearing of stock recommendations from my friends 80 something year old grandmother. Everyone is making money!
Fuelling this growth? The impressive exponential rise we have seen in the stock market, just look at the S&P 500 rebound since the lows of March 2020.
It’s now over 50% higher (+4370) as of writing today.
Pretty much everyone who invested in this timeframe is sitting on huge growth in their investments portfolio and their net worth.
But what comes with huge growth in stocks? Taxes!
Yes, if you have or plan on selling stocks to crystallize some of your gains from the recent bull market. Taxes, however boring they may be, should definitely be at the forefront of your mind!
Depending on your location, if you sell your investment (e.g., stock / ETF / index fund) the gain in value you achieved from that investment could be hit with a capital gains tax bill as high as 25%.
Check out the capital gains tax rate here depending on where you live in the world. For reference this tax you pay on the gain is referred to as Capital Gains Tax.
So let’s take an example from my current portfolio. I bought some Shell shares (RDSA) during 2020, and recently sold them due to the gain I was sitting on. I made a $5k profit on that sale from the original price I paid.
Now based on my location and my income level in Canada – I will be required to pay roughly 20% of that increase in Capital Gains tax come tax season. Or the equivalent of $1k. (20% of $5k).
As you can see the amount quickly adds up, if you are looking to sell multiple investments. You could be in line for a hefty tax bill.
The good news is there are ways to reduce the amount of capital gains tax you pay. One such way I have been taking action on is ‘Tax loss harvesting’.
So what exactly is tax loss harvesting and do you end up with some nice fresh vegetables at the end of it?
Sadly no on the vegetables, but with the money left in your pocket that you can save. Treating yourself to a visit to WholeFoods is definitely a side benefit you can splurge on.
At its most basic level tax loss harvesting is to purposely sell investments such as stocks / ETF’s / Index funds that have decreased in value since you have bought them. Essentially losers in your portfolio.
Why would you do this?
The reason is to offset this loss with a capital gain you made from selling other investments you have sold – such as the Shell example I mentioned above. You can essentially offset your gain in selling one stock with the loss from selling another.
But what if that stock you sell rebounds right after you sell it and you miss out on all those gains!
Well there is a way around this.
You can’t immediately buy that same investment back, that’s not allowed by the Tax regulators out there in the US, Canada etc. You have to wait at least 30 days to buy the same stock back (known as the Wash Sales Rule)
You are allowed to buy a similar investment, which can be directly correlated to the stock you sold.
Therefore if that stock rebounds you will still reap the rewards.
How I’ve used it and you can too? Let me show an example of how I did this recently in my portfolio.
Continuing the example above with Shell, I have a capital tax gain of $1k. Now looking through my portfolio I noticed my gold miner stock Barrick Gold (ABX) was sitting on a loss of $2k. (numbers rounded to simplify).
So what I did was sell half of my shares in Barrick to capitalize or ‘harvest’ that tax loss. This gave me a $1k capital loss which I can now offset against my $1k gain.
The result – no capital gains tax is now due when tax season rolls around from this sale.
But what if Barrick Gold rallies after I sell?
Well I immediately bought another gold miner, Newmont Corporation (NGT) whose stock price pretty much moves up and down in line with Barrick as the two largest gold miners in the world.
Thankfully I did, as over the next two weeks Barrick and Newmount both rallied over 5%. Buying a different investment in the same sector is one way of having some skin in the game to get around the 30 wash sales rule.
This is in essence the power of tax loss harvesting – as you now no longer have a capital gain tax bill if done correctly.
Leaving more money in your pocket come tax season – Wholefoods here I come….
Is tax loss harvesting worth it?
Tax loss harvesting is worth it! Aside from keeping money in your pocket and reducing your tax bill, tax-loss harvesting can increase your investment gains through the magic of compounding – one of the key pillars I am using to achieve financial freedom and retire by the age of 35.
That’s because making a loss comes with a trump card which you don’t have to play right away. It’s possible to hold off on the loss you’ve made in this year and use it against gains from past or even future tax years. It’s like a nest egg that can reduce your tax bills going forward.
Tax loss harvesting doesn’t just apply to individual stocks, but also to index funds, ETF’s and mutual funds. So for example if you have a loss on an ETF you own.
Currently I have a loss on Vanguards FTSE Emerging Markets All Cap Index ETF (VEE), I can sell that ETF and use the capital loss and just replace VEE with iShares Core MSCI Emerging Markets IMI Index ETF (XEC).
Both ETFs are directly correlated and track emerging market stocks so I won’t lose out on any potential upswings in the price.
Check out CandianCouchPotato.com for more – these have some great examples on ETF tax loss harvesting.
The other key advantage is a lot of online brokers actually offer this as a tool in your brokerage account and can identify and execute tax loss harvesting on your behalf.
Using this right is saving me thousands of dollars every year, while not missing out on investments rebounding.
Is there anything to be watch out for?
As I mentioned earlier, inquire with your brokerage if this is an automatic tax harvesting service they offer. For example, WealthSimple offers this as an automatic service.
I have focused on Canada and the US here, but there are similar tax rules in many countries around the world.
Also tax loss harvesting is generally not possible in retirement accounts (e.g. 401K, Roth, TFSA) as these accounts are already taxed advantaged.
Pro tip: Don’t wait until the end of the year to execute – check your account every couple of months for tax loss harvesting opportunities.
As I consistently preach, always do your own research. Check out your specific country’s circumstances and consult a professional (tax/financial advisor etc.) to confirm since all situations can be unique.
Take a look through my blog articles here, hopefully these will continue to help you on your financial journey going forward!
*As always, I am not an expert or financial advisor, so nothing on this website should be considered financial advice. These are just my opinions, everyone is different. Always do your own research and have your own independent thought process.
Catch you soon, here is to finding freedom.