All Is Not Lost
But as the saying goes, when the market hands you lemons, make lemonade – and there has been a bumper crop of lemons this year. While the losses are painful, they present the greatest chance to harvest portfolio losses in decades, and potentially rotate into strategies or exposures that better align with current goals or market conditions. Losses year to date are extensive, but should the fixed income and equity markets rebound strongly in the final months of the year, the opportunity may disappear. Losses have been recorded across most categories and, as of the end of July, 97% of all stock mutual funds, both active and passive, had negative returns. The likelihood of losses was even more prevalent in fixed income, given the pace and level of interest rate hikes since the start of the year. As of July 31, 99% of bond mutual funds had losses and performance during the third quarter did not improve the results. In fact, looking back over the last 20 years, this has been the worst year for performance – even worse than the Global Financial Crisis of 20081.
The Long and Short of It
When harvesting losses in a taxable portfolio, short- and long-term losses must first be used to offset gains of the same type – short-term losses to offset short-term gains and long-term losses to offset long-term gains. These losses can be used not only to offset gains on the sale of mutual funds or ETFs, but also to offset their annual capital gains distributions. If losses of one type exceed the gains of the same type, you can then apply the excess to the other type. If any losses remain after all the gains have been offset, the remaining losses may be used to offset up to $3000 of ordinary income on your 2022 tax return. Any remaining losses above the $3000 limit can be carried forward to future years.
Don't Get Washed Out
An important consideration when tax loss harvesting is the Wash Sale Rule. A wash sale occurs when an investor sells a position at a loss and also buys or acquires “substantially identical” investments within 30 days prior to or after the sale. The Wash Sale Rule also applies to any “substantially identical” investments an investor may hold in other accounts, or those purchased by a spouse or a company owned by the investor. For example, selling a security in a taxable account to take a loss, while purchasing a “substantially identical” security within the 60-day window in a retirement account, such as an IRA, would trigger the Wash Sale Rule.
With so few categories of mutual funds or ETFs showing positive returns for the year, there may be many opportunities for advisors to help their clients book losses against current and future gains. This also provides a good opportunity to assess investors’ underlying asset allocation and reposition to asset classes and managers that are better positioned for the inevitable bull market.
Natixis Investment Managers Solutions does not provide tax or legal advice. Please consult with a tax or legal professional prior to making any investment decisions.
This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary. The views and opinions expressed may change based on market and other conditions.
Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results.