In order to augment the benefits of tax loss harvesting the investor needs to reinvest the tax savings. by reinvesting we mean reinvesting tax savings in same securities?
Thank you.
Dear Chrisglo
If you have a “loser” security you will sell it at loss then use the proceeds to buy “Similar” but not necessarily the same security.
The point is that you dont deviate from risk exposures and investment strategy you had prior to selling the loser security unless your trade is meant to serve both goals (tax loss harvesting & adjust your portfolio’s exposure).
Thank you. so if one does not reinvest the tax savings, tax loss harvesting would not benefit the investor as tax wont be reduced.
i do not think that is the case. If you do not reinvest the tax savings in a similar security the size of your portfolio shrinks - and might have other impacts in terms of returns reduction (since the earning portfolio reduced).
reinvesting also resets the cost basis of the investment - to the new similar security’s current price. So due to the loss on the original security you get a tax advantage (loss reduces the total tax base) but the higher cost basis would have the net effect of a higher tax payout in a later year. it is a total zero sum game.
its a zero sum game if you don’t invest the tax savings and only reinvest the proceeds from the sale.
if you invest the tax savings as well as the proceeds from the sale and your return is positve you make more money than you would have by doing nothing.
To stress on what gringo_bob said:
tax savings here is not money that you get when you sell the loser security
its is the raise of your stock basis from lower basis (e.g. 10 : price when you first got that stock) and the new higher basis (e.g. 20: current price)
such change in the stock basis will enable you to DELAY the tax effect (time value of money).
Note that selling your security at 20 represents a loss to you as there are some lots of your holdings that were bought on a higher price (e.g. 30)
so, the phrase “Investing the tax savings” means that you will have to find ADDITIONAL sources of money to buy the stock, which is not the case in the concept of tax loss harvesting.
Everyone on this thread seems to be incorrect and the responses are incorrect.
I have a portfolio of $1,000. I realize $200 in gains, and have $200 in losses each year which i may or may not realize/harvest each year.
No harvest scenario: I realize my $200, and pay the tax (assume its $100). Therefore at the start of the next year my portfolio value is reduced by $100 (to $900)
Harvest scenario: I realize my $200, and also realize my $200 in losses. These offset, meaning I dont pay taxes, and there is no reduction in my portfolio value (stays at $1000)
Over time, the fact that you are using losses to offset gains will allow your portfolio to compound faster, as your value is not being reduced due to taxes each year. This is the value of harvesting losses. Of course, at some point you may not have losses to offset your gains, and your portfolio may be build up with a lot of gains, and you will take a tax hit when you need to sell…but again this is simply a play on the value of tax deferral.
Thank you all for your input. So tax loss harvesting would only become ‘useless’ when the losses ar insufficient to cover gains. Also, for tax loss harvesting to be beneficial using Mr Leverage example the $100 gain that you reaped must be left in the portfolio and not withdrawn.
chrisglo-not exactly.
So long as you have any losses that you realize you will have a tax benefit. In my example they offset entirely, but any losses will help to reduce the taxes you owe, which is a benefit.
Loss harvesting could be “useless” in a tax-exempt portfolio where there is no benefit to realizing losses (ie-foundations/endowments)
I wouldnt differentiate money being left in a portfolio versus withdrawn. Portfolios dont pay taxes, individuals or entities do. So the benefit of reduced taxes is for the individual. There are too many scenarios to discuss all of them. In the case of compounding a single portfolio then yes all money should be left in. In the overall case of an individuals wealth it doesnt really matter where the money is, just that there is now more of it cuz you didnt pay as much in taxes.
i have to disagree with what mr. leverage states:
@ both scenarios:
In tax loss harvesting, portfolio value has nothing to do with potential saving or its reversal;
- if we took the mentioned example (e.g. no harvest) and the result reached ($900), this means that you realized the gain by selling securities with a TOTAL value of $200, of which is definitely not the case.
- the same applies to the second scenario.
the whole point is about your “Original” and “New” COST BASIS relative to proceeds of SELLING your security, and consequently gain or loss on this sale, in other words, REALIZED gain or loss.
@ next year values in both scenarios:
Next year offsetting depends on whether or not you benefited from tax loss harvesting AND the price level of your NEW (replaced) security.
Here is an example:
- if you realized a loss by selling a loser security (A)
- you sold it at loss because you want to offset a gain from selling another winner security (B) in the same year, your taxes will be decreased by an amount (X).
After this, you have an option (depending on portfolio rebalancing decisions) to use the proceeds from sales to buy a “Similar” security to (A) say (A1) (we are still in year 1)
- if in year 2 the price of (A1) increased and you decided to sell it, then taxes would be higher than if you did not buy it in year 1.
That’s tax loss harvesting, it is all about certain securities within the portfolio and the effect of ACTUAL sales transactions on taxes, then if this savings could be offset next year. It has NOTHING to do total portfolio value.
ofcourse, for the tax-exmpt point, i totally agree with mr. leverage … after all its TAX-EXEMPT
Finally, if this debate caused you any confusion, then my advice to you is to leave all that and go to examples 12, 13 & 14 in the text book, then read carefully and watch out for words like
“realized” vs “unrealized”
"sell the securities”
“reinvest the proceeds AND tax savings”
@hopefully: I was referring to $200 in gains, not in market value, which should be clear from my post. I agree this is an important distinction but believe you are saying the same thing I did. I believe this covers your point on the important item being realized gain and losses.
In your second scenario (where A1 appreciates) I agree you pay more in taxes than if you didnt buy it, but you also have appreciation that you would not have had if you didnt purchase it. Not buying something for fear of future taxes is not loss harvesting.
I also disagree with your comment that it has nothing to do with portfolio value. Implementation of a loss harvesting strategy (in isolation), will lead to higher portfolio value (unrealized), as the lower taxes paid due to loss harvesting will lead to less capital used to pay taxes (assuming this is the only asset and source of funds). Therefore, which should be obvious, you use loss harvesting strategy as it can lead to higher portfolio value over time.
I dont have the book materials (luckily am done with the exams), but I do have a lot of practical experience with tax-managed portfolios.
Hi mr. leverage
for sure my dear i dont doubt your practical experience, am just trying to explain (the case) within the curriculum which we, not like you, did not finish yet … wish us luck 
as for our disagreement:
the orginal post by chrisglo was asking a simple question which is:
do we have to buy the same security in tax loss harvesting (e.g. A)
and the answer (at the very begining) was as simple as this:
NO we can buy similar security (e.g. A1)
Remember that for (A1) it is a “Similar” security to (A) which is the precondition for your trade in the first… you have to replace the loser security with similar security, thus, it does not matter wheather your portfolio contains (A) or (A1) …roughly speaking ofcourse. in other words. if you did not sell (A) and (A1) appreciates, then most probably (A) will appreciate too.
for your second comment about isolation, i also have to disagree… implementing tax loss harvesting neccessitates that you sell (realize) both the loss as well as the gains to be offset by tax benefit which, intuatively will affect your portfolio value, but we can not determine in which way the value will be affected unless the whole scenario is presented, a matter which is not part of our study.
in the case presented in the curriculum, replacement security (A1) aprreciates and tax benefit was offset… that simple. the curriculum does not refer in any case to the value of portfolio because, as you mentioned earlier, there are many scenarios for what would be the conditions, but as i said, and i assume all candidates like me think the same, my top priority is the curriculum.
So, we can go through tens of situations which will support the opinion of each one of us, because we tailor it, but again this is not the case of our study.
Again i totally respect your opinon and contribution.
thanks
In scenario 2 shouldn’t the portfolio value fall to $800 as now you are realizing losses worth $200? Please note that the $1000 includes the $200 gain but not the $200 losses as they are still unrealized.