Harvest Season: Making The Most Of Your Losses.

Last summer we did an entire series on Capital Gains and Losses. If you want to review what we said then and what was our logic for taking these losses go to these posts: Tax Loss Synopsis, Losses in Taxable Accounts and Losses in Tax Deferred Accounts.

Turns out others agree with me, especially when it comes to ETFs. Below is an article in ETFR Magazine that makes most of my same arguments. Below are excerpts. Highlights are mine.

"For the majority of investors, 2009 has been a year of recovery and some chunky capital gains; in other words the complete opposite of the previous one. For those who are invested in ETFs, such a volatile back-to-back performance has created the perfect environment in which to harvest capital losses in order to maximize returns.

Tax loss harvesting works like this: If an investor is showing losses on a particular security, he or she can sell that security and book the capital loss for tax reasons. The investor then has one of two choices: either keep their money in the new securities, or switch back into the original investment, after no less than 30 days. In either case, the result is that the loss incurred on the original investment can be rolled over into profits elsewhere, reducing the amount of capital gains tax the investor ends up paying.

There is nowhere this strategy makes more sense than in the world of ETFs. With a rapidly expanding number of funds, along with record sums in assets under management this year, its getting easier and easier to find ETFs that are almost exactly correlated to one another......

Tax loss harvesting is about the closest thing to a free lunch in investing. You sell one position and buy another that will give a similar performance, hold it for 30 days, and switch back.....

The IRS does have some rules around exactly what can and cannot be swapped and qualify for a tax loss. Specifically the IRS requires that two products cannot be 'substantially similar'; it doesn't want you making the swap exclusively for tax reasons, selling one security and immediately buying it back. It requires the two securities to be different.

Unfortunately, they've never said exactly what that means and {one} can find advisers who are cautious or aggressive in interpreting this mandate.....Most people agree that two funds tracking different indexes meet the IRS' guidelines, but in practice, there will never be a major month-to-month variance in performance between {different funds that basically track the same index but are comprised of certain different components}.....

An investor should always consider transaction costs and trading risk when executing tax loss harvesting strategies, but generally speaking, it's a straightforward way to boost overall returns."

Comment: There is a bit more to this subject than what this article briefly sketches out. I'd refer you again to my series on this topic if you would like a bit more detail. Here is however someone else making my same arguments regarding losses. The article also sites certain examples of how this could be done using specific ETFS which I don't believe are germaine to this post. I have a copy of this article and I would be willing to discuss the examples Harrison uses should any of my readers be interested. Also a brief reminder that we at Lumen Capital Management, LLC are not in the business of giving out tax advice regarding portfolios. Individuals should consult with their own tax advisers and also talk to their own investment advisers before implementing these kind of strategies.

Source: "Harvest Season: Making the Most of Your Losses", Daniel Harrison, ETFR Magazine, November 2009, Pages 6 & 12.