Tax Loss Harvesting

Current market volatility can present an ideal opportunity regarding Tax Loss Harvesting for hedge funds to realize losses for the benefit of offsetting future capital gains tax, and we at Akram are prepared to help our clients navigate the intimidating tax rules.

Breaching tax rules can diminish or negate any potential benefit of realizing short term capital losses, but with proper planning alongside our team, transactions analysis can help yield a substantial tax benefit. While Tax Loss Harvesting is often reserved for end of year planning, the midyear market condition may present a limited window of opportunity.

Timing of Capital Losses

Short Term Capital Gains/(Losses) are defined securities held for less than one year and are taxed at the same rate as ordinary income tax rates. Long Term Capital Gains are securities held longer than a year, and are taxed at a maximum of 20% plus 3.8% net investment income tax. A Short Term Capital Loss first offsets Short Term Capital Gains then Long Term Capital Gains, while a Long Term Capital Loss first offsets a Long Term Capital Gain. Short term capital gains are taxed at the ordinary income tax rate, making it is more advantageous to harvest short term capital losses.

Wash Sale

The most common mistake taxpayers make in attempting to harvest tax losses is failing to account for the Wash Sale Rule, which prohibits recognition of a loss if security or contract is reacquired in a 60-day period, beginning 30 days before the sale and ending 30 days after the sale. With proper tax planning, clients can realize the loss while maintaining exposure to the security. Most simply, a stock of competing company can avoid the wash sale rule while still being exposed to the industry. Another strategy for avoiding a Was Sale is making a Mark to Market (Code Section 475f) election, only if you are eligible for Tax Trader Status (“TTS”).

Offsetting Position

When considering tax loss harvesting, investment positions that offset must be approached with special care. Offsetting positions are used to manage risk, where two instruments serve to mitigate each other, for example a long common stock and a short position.

State Income Tax

Individual taxpayers can use up to $3,000 of excess losses to offset ordinary income on their form 1040, and the majority of states abide by this same rule. New Jersey, for example, does not allow losses to be deducted against other categories of income nor allows losses to be carried forward to offset future capital gains. The goal of effective Tax Loss Harvesting is to defer tax payment, so any tax savings can be invested and make returns in the meantime. The fruits of Tax Loss Harvesting are greater if you are in a higher tax bracket, combined with anticipated capital gains. If a Tax Loss Harvesting Consultation could benefit you, please contact the Akram Team.