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Market Commentary: A Late Summer Harvest

The financial news over these last 10 days seems like a steady stream of negativity. Triple-digit market loss, after triple-digit market loss will certainly create some aches and pains for those of us who have money invested in equities here and around the globe. While a loss is a loss, and nothing, but time, will bring back the gains we saw in investment accounts as recently as earlier this month, there are strategies to take some of the sting out of these most recent injuries.


One strategy that we are implementing here at the firm is called tax-loss harvesting. Simply put, it means selling a losing position for a loss while using those proceeds to purchase a similar position while it is low. The goal here is to create a current tax-deductible loss while also positioning a portfolio to reap tax-deferred profits in the years ahead. The reason that we purchase a similar position to the one we have just sold is because we do not want to make broad stroke strategy changes to a long-term portfolio. We simply want to take advantage of the current environment and the opportunities it is giving us to make tax-friendly decisions. With virtually all sectors of the U.S. market well-off their 52-week highs, now is an ideal time to say "if we can't have gains, maybe we can have less taxes."


Think about this...according to the IRS, an individual, if married and filing jointly, can deduct up to $3,000 to reduce other income ($1,500 if filing separately). If the net investment losses are greater than $3,000, the remaining amount can be carried over to the next year and used there, as if you earned it next year. You read that correctly, we can use losses that are occurring as we speak to help offset income in future years when you may or may not have the opportunity to find new losses to harvest. And THAT is how we turn a downturn into upside. And simply by taking what the market is giving us (and taking advantage of a nice piece of IRS code).


The above paragraph is not a blessing to go sell all of your stocks and replace them with something similar. This should never be done without the careful hand of an advisor by your side. First of all, it can only be done in non-qualified accounts (non-IRA, 401k, 403b, ROTH accounts). Obviously, there is no need to harvest tax loss on an account where taxes are deferred until retirement. Additionally, tax specialists will caution that there are plenty of rules and potential pitfalls in undertaking this strategy. Among them, you cannot sell one position only to be a substantially similar position with the proceeds (for example, you can't sell an S&P 500 index fund, only to by an S&P 500 index fund). You can't sell a position from your brokerage account only to purchase the same position in your spouse's account.


It is also important to understand the potential long-term impact on your capital gains tax rate. In today's tax code, there are several different capital gains rates. True, you are benefiting from a current tax deduction, but you are also creating a smaller cost basis for the new investment, which creates the potential for higher gains and potentially a higher tax consequence later on. It is impossible for us to know what the tax code will look like beyond the 2016 election, but if you know now that your income will be higher in the coming years, then this should be a point of emphasis for you. If you are likely to be in the same, or similar, or better yet, lower, tax bracket in the future, then you have nothing to worry about.


I cannot emphasize enough how important it is to go over the potential use of this strategy with your financial advisor. Not only so you don't fall into any of the potential pitfalls, but so you maximize your opportunity. Within all positions there can be tax-losses to harvest, and we, like many firms, use software to help us identify them. For example, you may have a stock position that looks on the surface to have significant gain. However, if you have reinvested dividends, or purchased shares at different times, then there may be some underlying fruit worth picking.


The benefits of tax-loss harvesting can be significant. The opportunity to deduct losses now, use some of that loss to lower your current taxes, and then save additional losses from this year for future years is a tremendous advantage for those looking to save on taxes. It is one of the best benefits that a down market can give us. The bottom line is that with the market's current trajectory, it is going to be a struggle to get back to even before the end of 2015. I am not saying it won't happen, but it will take some work. It is appearing more and more likely that the tax-loss harvest opportunity might be the most significant benefit that the markets give us during this calendar year. If that is the case, why not take advantage?

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 Securities offered through American Portfolios Financial Services, Inc. Member FINRA/SIPC (FINRA/SIPC). American Portfolios Financial Services, Inc. and American Portfolios Advisors, Inc. are not affiliated with any other named business entities mentioned.

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