How much in harvested losses is enough?

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natureexplorer
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How much in harvested losses is enough?

Post by natureexplorer » Sun Oct 10, 2010 11:14 am

The first $3,000 of harvested losses have an obvious immediate benefit. The first $300,000 of harvested losses will provide this benefit for the next hundred years. Additional losses provide you with some of the benefits you have in a tax-advantaged account, i.e. you can rebalance more or switch funds if a better one becomes available. However what is the value of the losses that are in addition to what you will ever be able to use for your year tax deduction? Is there a point at which tax-loss harvesting diminishes in value so much that it just doesn't make sense anymore? Particularly when using ETFs where you lose bid-ask spreads?

Edited: some typos.
Last edited by natureexplorer on Sun Oct 10, 2010 11:23 am, edited 2 times in total.

dbr
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Post by dbr » Sun Oct 10, 2010 11:19 am

Harvested losses can provide flexibility in rebalancing, but the analysis might be tricky because harvesting a loss also sets the basis lower and leads to higher potential gains in future transactions. There would be a tricky interaction between capital gain timing and changes in personal tax exposure over time. Long term carryovers can still offset short term gains in the right circumstances. Thus, it could make sense to harvest absurd losses but I agree there is a serious question here.

Wagnerjb
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Re: How much in harvested losses is enough?

Post by Wagnerjb » Sun Oct 10, 2010 7:20 pm

natureexplorer wrote:Is there a point at which tax-loss harvesting diminishes in value so much that it just doesn't make sense anymore? Particularly when using ETFs where you lose bid-ask spreads?
Yes, there is a point where tax loss harvesting doesn't make sense, but you have to assess that for your personal situation.

At worst, tax loss harvesting benefits represent a tax deferral for a certain time period. At best, you have a permanent tax savings (if you bequeath the shares to your heirs). So first figure out what the benefits are, and when you will realize them. With a pile of tax loss carryovers, your realization may be way in the future, and that lessens the value of them.

Compare the present value of these benefits with the cost to harvest. The cost may be ETF bid-asked spreads, fees or the opportunity cost of sitting in a money market fund for 30 days.

With a huge tax loss carryforward it is easy to see how this cost-benefit analysis could result in a decision not to harvest an incremental loss today. I face this decision regularly too. In my case, I might not harvest a $1,000 loss, but I would consider one at $2,500. My pucker point is heavily influenced by the size of my tax loss carryforward.

Best wishes.
Andy

natureexplorer
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Re: How much in harvested losses is enough?

Post by natureexplorer » Sun Oct 10, 2010 8:15 pm

Wagnerjb wrote:At best, you have a permanent tax savings (if you bequeath the shares to your heirs).
I am talking about harvested losses that are in excess of of what you can deduct for income tax purposes. Therefore I don't see how harvesting losses in excess of say $300,000 would help your heirs. The losses die with the person and the cost basis just prior to death is irrelevant to my understanding.

In what scenario does it make sense to harvest absurd losses when using ETFs, i.e. a minimum cost of $0.01 per share to do so?

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tetractys
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Post by tetractys » Sun Oct 10, 2010 8:30 pm

So now we're progressing into the minutiae (Is that the right word spelled right?) of timing tax loss harvests. Or, is it timing? No matter, we are evolving here and that's good. -- Tet
RESISTANCE IS FRUITFUL

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gasman
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Re: How much in harvested losses is enough?

Post by gasman » Sun Oct 10, 2010 8:33 pm

natureexplorer wrote:
Wagnerjb wrote:At best, you have a permanent tax savings (if you bequeath the shares to your heirs).
I am talking about harvested losses that are in excess of of what you can deduct for income tax purposes. Therefore I don't see how harvesting losses in excess of say $300,000 would help your heirs. The losses die with the person and the cost basis just prior to death is irrelevant to my understanding.

In what scenario does it make sense to harvest absurd losses when using ETFs, i.e. a minimum cost of $0.01 per share to do so?
To a multi million dollar taxable portfolio, $300,000 in carry forward losses may simply offset future realized gains during rebalancing and during the withdrawal phase. Remember carryforward losses aren't to be used exclusively to offset $3,000/yr in ordinary income.

natureexplorer
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Re: How much in harvested losses is enough?

Post by natureexplorer » Sun Oct 10, 2010 8:38 pm

gasman wrote:To a multi million dollar taxable portfolio, $300,000 in carry forward losses may simply offset future realized gains during rebalancing and during the withdrawal phase.
During the withdrawal phase, will a lower cost basis not also mean that you will burn through your harvested losses more quickly? Not sure, I haven't done the math. But I am also not sure there is a free lunch.

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gasman
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Re: How much in harvested losses is enough?

Post by gasman » Sun Oct 10, 2010 9:29 pm

natureexplorer wrote:
gasman wrote:To a multi million dollar taxable portfolio, $300,000 in carry forward losses may simply offset future realized gains during rebalancing and during the withdrawal phase.
During the withdrawal phase, will a lower cost basis not also mean that you will burn through your harvested losses more quickly? Not sure, I haven't done the math. But I am also not sure there is a free lunch.
No free lunch, but a discounted one. I aggressively tax loss harvest. Took 100K plus in the last downturn. Used them to offset and finally sell some individual stocks that I have held since the early 90s that still had signficant unrealized gains. Of course, I purchased large cap index funds to maintain my allocation while eliminating single company risk.

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Post by livesoft » Sun Oct 10, 2010 9:30 pm

I used up 6-figure carryover losses from 2000 - 2002 by 2006. I intend to use up 6-figure carryover losses from 2007-2009 in retirement.

Let's face it, if your losses are $300K, then your portfolio is substantial. In retirement while drawing down your taxable assets, you will be using up those carryover losses. This will allow you to live on $100K per year tax-free for a number of years, but you should use that opportunity to convert some of your IRA/401(k) money to a Roth IRA while in a low tax bracket.

I think if you pay attention to your tax loss harvesting, that you can avoid the costs including the bid/ask spread and other costs. Presently, you should not be paying any commissions on your trades. As for the spread, you should go ahead and time your sales and buys appropriately. I have detailed elsewhere how I try to use relative value in this regard: http://www.bogleheads.org/forum/viewtop ... 901#742901 I won't say you are guaranteed to avoid bid/ask spread, but at least you should try.

So in my opinion, the only time it doesn't make sense to TLH is when you are dead or if your gains will be taxed at 0% anyways.

Wagnerjb
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Re: How much in harvested losses is enough?

Post by Wagnerjb » Mon Oct 11, 2010 8:18 am

natureexplorer wrote:
gasman wrote:To a multi million dollar taxable portfolio, $300,000 in carry forward losses may simply offset future realized gains during rebalancing and during the withdrawal phase.
During the withdrawal phase, will a lower cost basis not also mean that you will burn through your harvested losses more quickly? Not sure, I haven't done the math. But I am also not sure there is a free lunch.
If you sell the harvested stocks first in retirement, then I agree the situation could be a wash (no net gain). But if you are selling other assets (those not harvested), you may be able to use the tax losses for your benefit.

Keep in mind that the benefits don't have to be from stock sales. In 2001, I tax loss harvested aggressively and had several decades worth of annual $3,000 write-offs. Around that same time, my father-in-law passed away, leaving my wife with a 50% ownership in a rental home in Florida (it was their childhood home). In late 2006 I convinced my wife and her sister to sell the house, which had doubled in value during that time. That realized capital gain was fully covered by the tax losses.

My wife also inherited a few acres in Texas. A few years later they discovered natural gas on the property and we have been receiving modest royalty payments ever since. We regularly receive offers from brokers to purchase the property (or the mineral rights). The land had little value at the inheritance date, so if we were to sell (we won't), it would represent a handsome capital gain....that my tax losses can cover.

The cost-benefit analysis I described is valid. You just see a much lower likelihood of utilizing the incremental tax losses than others do. That doesn't make your decision wrong, but we are trying to help you see other possibilities for using the tax losses.

Best wishes.
Andy

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Post by matt » Mon Oct 11, 2010 9:28 am

livesoft wrote:Let's face it, if your losses are $300K, then your portfolio is substantial.
Or it used to be substantial, but you lost most of it.

Abbey
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Carryover losses & Roth conversions?

Post by Abbey » Sat Jan 01, 2011 11:47 pm

livesoft wrote: In retirement while drawing down your taxable assets, you will be using up those carryover losses. This will allow you to live on $100K per year tax-free for a number of years, but you should use that opportunity to convert some of your IRA/401(k) money to a Roth IRA while in a low tax bracket.
I didn't realize this was possible in retirement. Doesn't the conversion count as regular income?
Is is possible to use carryover losses to reduce income when converting IRA to Roth while still working or must you wait until retirement? As you can see, I don't quite get this and I'd appreciate any explanations you offer. Thanks.

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Post by DSInvestor » Sun Jan 02, 2011 12:52 am

Abbey, consider two retirees who sell stock worth 100K to realize 90K capital gain but only retiree 2 has capital loss carryovers. You will notice a big difference in taxable income and tax brackets.

Retiree 1 no capital loss carryovers:
Realized capital gain = 90,000
Net Realized capital gain = 90,000
AGI = 90K
MFJ Std deduction = 11,400
2 Exemptions = 7,300
Taxable Income = AGI - deductions - exemptions = $71,300 (25% bracket MFJ)

Any Roth conversion done by Retiree 1 will be taxed at 25% Fed. A large conversion may bump up into higher tax brackets.

Retiree 2 has 300K of loss carryovers:
Realized capital gain = $90,000
Net realized Capital Gain = $-3000 (all gains offset by loss carryovers plus 3K income reduction)
Capital loss carryover to next tax year = $207,000
AGI = $-3,000
MFJ Std deduction = $11,400
2 exemptions = $7,300
Taxable Income = $-21,700 (0% tax bracket)

Retiree 2 will be able to a Tax free Roth conversion of $21,700 to consume the 0% tax bracket. Retiree may have time to do a series of small tax free Roth conversions while withdrawing from the taxable account before pensions or social security benefits start.

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Post by GlennC » Sun Jan 02, 2011 1:22 am

You should make sure you don't run the risk of your tax losses expiring, if your taxation system does that.
I am one of those dirty active management people.

Abbey
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Post by Abbey » Sun Jan 02, 2011 11:03 am

DS Investor: Thanks for the easy explanation. I confused selling taxable with converting IRAs when it's a two step process. This will be a great way to convert to Roth in early retirement assuming we haven't used up all our losses. :) Abbey

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Post by Doc » Sun Jan 02, 2011 12:00 pm

DSInvestor wrote:Abbey, consider two retirees who sell stock worth 100K to realize 90K capital gain but only retiree 2 has capital loss carryovers. You will notice a big difference in taxable income and tax brackets.
But the person who took the losses has a higher basis and therefore a bigger gain - so no direct benefit when considering the portfolio as a whole. In general, capital loss carry forward beyond the $3k write off of ordinary income are only a deferral of income tax on "non-loss" assets. How much benefit this deferral means to the individual depends on future tax rates, other assets that may or may not have gains and possibly inheritance consequences. These are highly personal considerations and any broad statement is likely to be wrong for a particular individual.
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Taylor Larimore
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Taking tax-losses if available?

Post by Taylor Larimore » Sun Jan 02, 2011 12:23 pm

Hi NatureExplorer:
How much in harvested losses is enough?
I retired nearly 30 years ago. When we first started withdrawing from our taxable account, we were able to offset our taxable income with loss-carryforwards. The result was that we paid very low taxes during the early years of our retirement!

Based on my experience, and with few exceptions, I doubt if it is possible to have "enough" tax-loss carryforwards. My advice: Take tax-losses when available.
"Simplicity is the master key to financial success." -- Jack Bogle

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grabiner
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Remember, you will have to sell eventually

Post by grabiner » Sun Jan 02, 2011 10:05 pm

The long-term benefit of harvesting losses is to postpone gains as long as possible into the future. For example, suppose that you have $30K of carried-over losses already, and have stock worth $800K with a basis of $1M. If you sell, you have a $200K loss carry-over. Then, ten years later, your stock doubles in value to $1.6M, you still have $200K of carried-over losses, and you need to sell $320K of stock to rebalance or to spend the money. Because you harvested the loss, you can sell $320K with a $160K basis and pay no tax. If you hadn't harvested, you would sell $320K with a $200K basis and pay tax on a $120K gain.

In addition, you may postpone the tax forever. If you buy stock with a harvest and then donate the stock to charity, you have eliminated the potential taxable gain.
Wiki David Grabiner

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