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Benjamin Schmitz

What is robo tax loss harvesting?


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If you’re using a robo advisor to manage your money, you probably get tax loss harvesting as a service. Tax loss harvesting is simply a way to offset capital gains by deliberately selling off securities at a loss, so your overall tax bill is lowered. You can do this on your own as an individual investor, but it takes a bit of work. If your money is managed by a robo advisor, this is automatically done for you. Under the new 2018 tax law, long-term capital gains are taxed at either 0%, 15%, or 20%, depending on your income bracket, and short-term capital gains are taxed at the same rate as your ordinary income. If you are in the highest tax bracket and you have gains of $20,000 in a non-sheltered brokerage account, your tax bill would be $4,000 at the end of the year. On the other hand, if you sold a lot of stock at a loss of $12,000, you could deduct that amount from your capital gains, reducing your tax liability to just 20% of $8,000, or $1,600. It’s not quite as simple as that, but that’s the basic principle behind tax loss harvesting. Most robo advisor portfolios are built around ETFs and are continually rebalanced automatically so that your exposure to a particular sector, industry, or market remains constant and in accord with the portfolio’s stated composition and objectives. This means that funds are constantly being bought and sold within the portfolio, potentially triggering taxable events. A robo advisor offering tax loss harvesting will automatically sell a fund at a loss to offset the gain and make a new fund purchase to keep your portfolio balanced. There’s a catch in the tax law, however, which is one of the reasons tax loss harvesting is so complicated for individual investors. The IRS has a wash-sale rule, which prohibits an investor from purchasing a “substantially identical” asset to the one that was sold at a loss within 30 days from the date of the sale and still claim the loss. In other words, if you sold XYZ stock at a loss for tax purposes and then turned around and repurchased XYZ the next day, you cannot use the loss to offset gains. The robo advisor will make the appropriate lot sales of ETFs to offset gains, and then sift through the thousands of ETFs to find one that closely resembles the one that was sold, but not so much it trips the IRS wash-sale rule. In this way, taxable events are kept to a minimum and your portfolio remains balanced with the right ratios of exposure. This automated tax loss harvesting is a real benefit for robo investors and actually boosts returns compared to portfolios managed by human advisors. Two of the larger robo platforms, Betterment and Wealthfront, state their automated tax loss harvesting adds between 0.5% and 1.5% to their portfolio returns. If you are choosing a robo advisor, it pays to look for one that automates tax loss harvesting for you.

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