By: Joe Delaney
Have you ever heard of a Meyer lemon? Much sweeter than regular lemons, this tasty fruit is generally available December through May.
But what does the Meyer lemon have to do with investing? More than just its availability during tax season.
We’ve all heard the expression, “When life gives you lemons, make lemonade.” One of the most fitting uses of this colloquialism in investing is when it’s applied to the topic of tax loss harvesting. This option is the one bright side of experiencing a significant loss in stock value: you have an opportunity to “realize” the loss, sell off the stock and report the difference from the purchase price to offset future capital gains. You can then reinvest the recovered funds to keep your portfolio balanced.
This becomes a great benefit come tax season, if done correctly. You must keep many factors in mind to maximize the benefits on your return while keeping the health of your portfolio in mind.
These include, but are not limited to:
1. Income Threshold – There are limitations to how much you can use to reduce taxable income.
2. Administrative Cost – It makes sense to harvest the tax loss only if the benefit outweighs cost.
3. IRS Regulations – Reinvestment of remaining stock value may be made in a similar asset to keep your market exposure (degree of risk) relatively constant, but the asset must not be considered “substantially identical” to avoid the IRS “wash-sale rule”. The wash-sale rule applies to the 30 days before and after the sale.
The process is a bit like pruning a tree. You need to know when to prune, where and how much to ensure the overall health of the tree. If you don’t follow the rules you’ll wind up hurting more than you’re helping. Any orchardist will take advantage of the opportunity of a sour lemon harvest to make lemonade, but lemonade is a consolation. What if next year we did even better, and turned our lemons into oranges instead?
This isn’t unheard of in nature. According to thekitchn.com, the Meyer lemon is actually a cross between a lemon and an orange. They appear smaller, rounder and more orange in color; in other words, they are – somewhere along the evolutionary line – lemons turned oranges. Maybe you can’t literally plant a lemon tree and get oranges in a single season, but with the help of an experienced financial advisor guiding you through the tax loss harvesting process, you can use the resources you’ve gleaned this year to get a sweeter fruit in the next than you ever thought possible.