How This Year's Painful Losses Can Help Your Client's Tax Situation

As we wade deeper into the fourth quarter, financial advisors are doing their best to make lemonade out of the lemons that are their clients’ asset portfolios. For many, now is an opportune time to discuss tax-loss harvesting with clients.

In fact, according to Michael Lane, head of iShares US Wealth Advisory at BlackRock, there hasn’t been an opportunity like this in almost 50 years.

Lane recently joined Ric Edelman, founder of the Digital Assets Council of Financial Professionals, on Ric’s radio show and podcast The Truth About Your Future. The pair discussed some of the technical details of how to reduce or avoid capital gains that advisors need to know and prepare for.

The following are edited excerpts from their conversation.

Ric Edelman: This has been one of the worst years for the financial markets in several decades. However, there is a narrow window for advisors to help their clients lower their taxes thanks to the lousy market we’ve had this year. Michael, 2022 is the ultimate year for tax management. What do advisors need to know?

Michael Lane: This is an unprecedented year. You have to go back almost 50 years to have an opportunity like this to harvest losses and establish an opportunity for you to use those losses going forward for the next five or 10 years. That’s because capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year. And net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.

Ric: People tend to focus on their returns. They tend to look at how much money are they making in their account. What people tend to forget is it’s not what you earn that matters, it’s what you keep.

Michael: That’s right. Most people focus on the total return and they focus on cost. People will sell things to save one basis point or two basis points. Say you had a fund that was worth $100,000 and it was going to distribute, say, a 5% capital gain this year. Even though you lost money it is still going to distribute a 5% capital gain.

If you just look at a typical person that’s paying normal capital gains tax rates, that actually costs you $150, which is 15 basis points. That’s 15 times what a lot of people will look at as the primary focus when they’re building their portfolios and just looking at the cost of it.

Ric: So I think this is what confounds a lot of people, Michael, is that they don’t understand how in a year like this, with the stock and bond markets down, how can there be capital gain distributions in their funds? How can they have gains in the middle of a year of losses?

Michael: At the beginning of the year, you could be down 25 or 30% this year and then get a tax bill for thousands of dollars on the distribution from that mutual fund. That’s because the portfolio manager probably had to sell certain securities in the fund that he or she may have held for many, many years. Now they distribute the capital gains to you.

Even if you have a loss, you could get a tax bill. So you need to manage your tax concerns before the end of the year.

Ric: What work should advisors be doing now to help mitigate the tax bite of capital gains?