Summary

• There is only two weeks remaining to institute this Tax Loss Harvesting strategy.
• This strategy potentially reduces taxes due while maintaining exposure to the targeted stock.
• With the advent of online inexpensive trades, this year end strategy should be a no-brainer.

I preface this article with the admission I am not a tax advisor and all tax issues should be reviewed with your tax preparer or accountant. This time of year, a portfolio strategy can positively affect your taxes due next April. It is known as tax loss harvesting. The concept is pretty simple, but it can save/delay realized capital gains taxes due until sometime in the future. However, it is important to understand this strategy only applies to non-tax-advantaged accounts, as IRA capital gains are not taxed annually. In addition, it is important to act in a timely fashion as you only have until Nov 30 to implement the strategy.

While we all hope to have a perfect batting average with our investment selections, it unfortunately does not work that way. There are times when a selection proves not the best and there is a capital loss on the position. In addition, most investors do not like to take losses and sometimes will hold onto stocks long after they should have been sold.

Long-term capital gains tax due is based on the difference between realized gains and realized losses. In other words, realizing long-term capital losses lowers the capital gains taxes due from realized gains. From this differential, the tax rate is 20% of the overall gain.

Short-term capital gains are directly added to taxable income and are taxed as ordinary income. Short-term losses are directly deducted from taxable income, reducing overall taxes due.

In the month of November, all investors should review their realized gains and losses year to date to evaluate their potential taxes due. In addition, investors should review current positions that are creating losses.

The strategy is to first determine if the position is still desirable and if it is anticipated to eventually accomplish your objective. For example, the market is down and the stock is reacting to an overall decline or there is a short-term and unexpected corporate profitability issue that will be resolved in the future. If the downturn in price is considered temporary, it may be time to harvest the loss.

However, there is one catch called the Wash Sale Rule. The IRS does not allow investors to realize a loss unless they are out of the position for more than 30 days. If you sell and then rebuy within the 30-day window, the loss is disallowed. Human nature is that when sold, many investors would move on to different opportunities and never rebuy the position after harvesting the loss.

The cure for this is to double down on the position in the month of Nov. with the strategy to sell the original position after 31 days, realizing the loss and maintaining a position in the stock.

It is imperative if you chose this avenue to specify which tax lot purchase is being sold during the selling process. Many online broker accounts allow investors to specify which purchase lot is being sold.

For example, you bought 150 shares of Chicago Bridge and Iron (NYSE:CBI ) at $70 a share ($10,500) and it is now trading at $50 ($7,500). The position would have a loss of $3,000. Purchasing an additional $10,500 or 210 shares at $50 in Nov, waiting 31 days, and then selling the original 150 shares in Dec will accomplish several important goals:

• A $3,000 loss is harvested which reduces taxes due from either other long-term gains or from earned income, depending on the holding time of the original investment.
• The position in CBI is maintained.

With the advent of $10 trades, this strategy becomes almost a no brainer, as transaction costs are minimal.

However, keep in mind with the new lower cost on the position, future capital gain tax will be higher as a loss will have been harvested. Nevertheless, at a minimum, taxes due for 2014 will have been reduced and the offsetting increase will not be realized until the second purchase is sold sometime in the future.

Some advisors look to sell in December and rebuy during the following Jan to harvest losses. I prefer not to be out of the position and prefer the approach of doubling down on good quality stocks currently offering unrealized losses in my account. Tax loss harvesting should become a standard investment strategy to reduce current tax liabilities.

Disclosure: The author is long CBI. (More. ) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.