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Thursday, November 26, 2015

The Other Way To Harvest Tax Losses

Tax-loss harvesting is a strategy to offset capital gains and so limit tax liability. It is usually done by intentionally selling a losing position to limit the recognition of short-term capital gains, which are taxed at higher federal income tax rates.

Even if a taxpayer does not have capital gains to offset, tax-loss harvesting can be beneficial. Up to $3,000 of a realized loss can be used to offset the taxpayer's income in the given tax year. Additional capital losses can be carried over and used in subsequent tax years.

To discourage tax-loss harvesting, the IRS (Internal Revenue Service) disallows taxpayers from claiming losses on so-called wash sales. Investors have to wait 31 days before repurchasing an investment sold at a loss. The wash rule also prohibits buying anything substantially similar, including options to buy the stock.

Although tax-loss harvesting can potentially reduce your tax bill, there are certain risks to consider

If you sell a losing position and wait 31 days to buy it back, you could end up paying more than you sold it for. Furthermore, while you wait your money is not working for you. You could buy a replacement stock, but that would involve incurring additional transaction costs and potentially change the character of your portfolio. Also, buying back the original position would reset the cost basis, probably to a much lower amount. If the price increases and you decide to sell the position again, you'll end up with a larger taxable gain than if you never sold in the first place.

Dividend investors can benefit from tax-loss harvesting, too. If you sell dividend paying stocks to harvest tax losses, you'd want to consider the ex-dividend dates of those stocks. Giving up a dividend payment probably is not worth the potential tax benefit...

There are many fine points about tax-loss harvesting to consider, including details about the aforementioned wash rule and how to treat qualified dividends. For example, if you hold a position for less than 61 days and receive qualified dividends from that position, the dividends no longer qualify for preferential tax treatment.

Buy, then sell

Selling a losing position in December to harvest a tax loss is potentially risky. Due to the January effect, a hypothesis that stocks tend to go up at the beginning of the year more than other times, buying back shares in January could cost you more...

Instead, you could double down by buying an equivalent number of shares in November, wait 31 days and then sell the original position in December before year's end. 

In following this approach, you could benefit from the Santa Clause rally when stock prices generally increase over the final week of trading. If indeed the stock price increases, you'll end up with a smaller loss on your original position and a gain on the new position.

Of course, you need cash on hand to harvest tax-losses in this way!

QCOM Tax-Loss Harvesting

While reviewing my portfolio to see if I could benefit from tax-loss harvesting, I noticed that Qualcomm Inc (NASDAQ:QCOM) is a candidate. At the current price of $49.10, my QCOM position shows an unrealized loss of $1,228 (or nearly 25%).

What makes QCOM more attractive for tax-loss harvesting is that the company's stock will trade ex-dividend on Friday. By buying shares now I can grab a larger dividend! 

Here's the trade:

Nov 24, 2015: Bought 90 shares of QCOM at $49.32 per share.

QCOM is a Dividend Contender with a track record of 13 consecutive years of dividend increases. The company pays quarterly dividends of 48¢ per share in the months of March, June, September and December.

I bought shares of QCOM in April 2015 and again in July 2015. I own 75 shares at an average cost basis of $66.20 per share. Yield on cost (YoC) is 2.90%.

The new buy adds 90 shares at an initial YoC of 3.89%. 

I plan to sell the original 75 shares at the end of December 2015 and report the tax consequences at that time. 

What do you think of tax-loss harvesting? Any concerns you have applying the strategy to dividend growth stocks? Please comment below!


  1. Hi DivGro,

    I am glad you are thinking of tax loss harvesting for companies you are interested in.

    As many of my energy picks have been going down ( or had been down in August/September), I did quite a lot of TLH.

    If I owned QCOM however, and did TLH, I would have doubled the position like you did. However, I would also sell a covered call that expires at least 32 days from now to lock in the price for the first shares I owned. Then I would have bought a protective put on the original shares to protect me in case my shares went down. The goal is to harvest losses, not increase my risk in the position by a factor of two.

    Thanks for your mention by the way.


    1. Thanks for commenting, DGI -- and for sharing the nuances of your risk management strategy. I'm guessing the call and put would essentially be offsetting, correct? I can see how that would mitigate risk.

      For now, I don't have the flexibility of doing something similar and I'll have to live with the increased risk. First, the brokerage hosting my DivGro portfolio does not offer options, presently, and I don't have at least 100 shares of QCOM to execute such trades.

      I'm sure other readers would benefit from your comment, though, so thanks again!

  2. I've never done tax loss harvesting in prior years but will be considering it in the future. Not necessarily this year as I'm thinking of trying to maximize some gains due to our lower tax rate, although I'm not 100% sold on selling just to step up the cost basis. The dividend stream would remain the same, less transaction costs, but the YOC would suffer although that's just a backward looking metric anyways and doesn't change what your portfolio actually churns out based on the current value. Whenever I do go after some tax loss harvesting in the future my plan is to go the route of purchasing shares beforehand and then selling the original lots just like you did with QCOM. It can be beneficial if your positions are somewhat sizable and are sitting on hefty losses, but you have to make sure it's worth it to go through the hassle.

    1. Thanks for visiting! It is good that you're thinking about tax-loss harvesting in relation to your current tax rate... that's an important consideration that I didn't mention in the article. So of the articles I link to do, however.

      Taking a loss on my QCOM position would benefit me at tax time. I'm also taking the opportunity to buy more shares (at a lower price) than I would be selling at the end of December. If I had more cash on hand, I would have bought 100 shares (about $5,000 in capital). Obviously, having more shares increases my projected dividend income.

      Take care!

  3. Interesting article, there is not enough tax analysis out there in the dividend community.

    1. Thanks, Ben -- I just barely scratched the surface here. I'm certainly not a tax expert and there seems to be a lot of details to be aware of. With this article (and the follow-up in December), I'm trying to learn and share, hopefully something useful!


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