Another Caveat for Tax Loss Harvesting

Our February 11, 2018, blog posting covered “tax loss harvesting” as a strategy to assist in the management of an investor’s income tax liability.  To recap, the U.S. tax code allows realized capital losses from taxable investments to be utilized to offset realized capital gains.  Further, there exists the possibility that ordinary income can also be offset (to a degree) by realized losses.  The previous blog cautioned readers about the possibility of running afoul of the IRS’ “wash sale” rules when mutual fund distributions are being reinvested in the same fund being sold at a loss.

An additional technicality for employing this loss harvesting strategy is to make sure that the taxpayer is not purchasing the “substantially identical” investment elsewhere in his/her portfolio during the period of time when the “wash sale” rules apply.  Doing so will have the same effect as the reinvested dividend mistake referenced in the February 11 posting.

Here is an example.  Suppose an investor sells Fund XYZ at a loss in his/her taxable investment account.  This investor also has an on-going automatic investment program set up which moves money on a monthly basis from their bank checking account into their Roth IRA.  If the funds being moved into the Roth IRA are being directed to the purchase of Fund XYZ, it’s virtually certain that a violation of the “wash sale” rule has taken place, and some or all of the realized loss in the taxable account will be disallowed on that year’s income tax return.  The IRS takes the position that such offsetting transactions will result in no net material change in the taxpayers’ overall financial position, since the losing investment was re-acquired elsewhere in the investors overall portfolio.