You may recall an earlier post where I was trying to figure out how long to stay at my job in 2016. I decided to stay until we had to start paying a lot in taxes. (Epilogue: I ended up staying a week or two longer since my caseload emptied and I was getting paid to do nothing.)
Our taxes for 2016 will still be pretty low. But we are looking at combined gross income of $82k (not bad for seven weeks of work) and adjustments of $37k (mostly things like 401(k) contributions, etc.). That adjusted gross income can be reduced further by our personal exemption amounts and the standard deduction. On top of that, we have about $27k of qualified dividends plus some state tax refunds for 2015. That amount of income and deductions puts us in the 10% tax bracket, where the dividends will be subject to a long term capital gains rate of 0%.
It just so happens that we had two ETF holdings that were begging to be consolidated into our core holdings of Vanguard Total Market and Total International mutual funds. I bought these back in 2011 when we used Wells Fargo for our brokerage due to their free trades. These holding now had a combined gain of just over $10k. Instead of adding to our taxable income, we decided to do some tax loss harvesting to offset the gains and reduce our taxable income by an additional $3k.
Here’s what we did and what I learned from the experience.
The first thing I did was to sell the ETFs to lock in the gain to provide a fixed baseline. So we locked in the $10k gain and used the proceeds to purchase our core holdings.
One of the core holdings happened to have more than enough losses to offset the gain. But we could not immediately sell positions in that fund due to the wash sale rule, which says your losses will be disallowed if you buy a substantially similar security either 30 days before or after a sale for a loss. So we had to wait until 30 days had elapsed after reinvesting the ETF shares.
Now we were in the clear to take the loss. I determined the specific lots that had the greatest losses to minimize the amount of the transaction. Then I exchanged them to a different fund (call it a temporary holding fund) — this ensures we would not miss out on any gains. The losses amounted to almost $12k.
Now we had locked in a net loss of $2k. The next thing to worry about is clearing the 30 days after the sale. We own the fund that was sold for a loss in other accounts as well. We had to make sure to turn off dividend reinvestment for all instances of that fund because even a dividend reinvestment will trigger the wash sale rule.
Finally, we cleared 30 days after the sale and we were able to exchange the temporary holding fund back to our core fund. But the temporary holding fund had gained almost $3k! We did not want to lock in more gains only to have to offset them again later. By waiting a few days, we took advantage of a temporary lull and did the exchange at a $2.5k loss.
So after all that, we completely offset the gains from the ETFs, consolidated our portfolio, booked an additional $3k adjustment to income and have another $1.5k loss that we can carry forward to future years.
The wash sale rule really made this transaction difficult. It’s really important to have all the timing mapped out in advance, including dates of dividend payments.
Unless you are selling for cash, it’s impossible to tax loss harvest for an exact amount. I did not anticipate having to account for short term gains and losses in the temporary holding fund. We went from looking at gains one day to losses the other. Short term gains can only be offset short term losses…
Having multiple holdings of the same fund can really complicate things. Even if a spouse makes a purchase, that can cause your losses to be disallowed.
We should have done more tax loss harvesting when we were at the 39.6% bracket, instead of the 10% bracket!