Private wealth tax loss harvesting

CFA Level III Portfolio Management
#1

Wald has a realized capital gain of CLC 50,000 in another taxable account. Her advisor reviews that account and notices that Stock Y has an unrealized loss of CLC 45,000 and a cost basis of CLC 220,000. The advisor explains two alternate plans to Wald:
Plan A: Sell Stock Y in Year 1 to realize the loss and replace it with Stock Z, which the advisor believes will have the same expected return as Stock Y. In Year 2, sell Stock Z at an expected market value of CLC 250,000.
Plan B: Hold Stock Y until Year 2 and then sell it at an expected market value of CLC 250,000.
Tax = 20%
Demonstrate that the amount of Wald’s total two-year tax liability is the same for both plans.

Plan A: Year 1: 0,2x(50k - 45k) = 1k. Buy securities with similar return, they are worth 220k-45k = 175k
Year 2: 0,2x(250k - 175k) = 15k
Total tax liability: 16k
Plan B: Year 1: 0,2x50k = 10k
Year 2: 0,2x(250k -220k) = 6k
Total tax liability: 16k

Explain how plan A could increase Wald´s expected after-tax account value.
Answer: A subtle advantage of tax loss harvesting is pushing a portion of the tax liability into subsequent years, even though the two-year tax liability does not change. Recognizing an already incurred loss for tax purposes saves taxes in the current year and thus increases the amount of net-of-tax money available for investment. Assuming, on average, positive portfolio returns, this larger investment will lead to a greater future wealth accumulation

Could someone pls re-word this explanation?
Do I understand it correctly: you save taxes today, but owe them later (push liability into subsequent years).
You reset your cost basis by the recognized loss -> will have a larger gain, and hence a larger after-tax wealth?

#2

Using tax-loss harvesting strategy, sell Stock Y to reduce taxes. The proceeds from Stock Y AND tax savings are reinvested into similar securities to maximize the after-tax future value of assets/investments.

#3

“increases the amount available for investment”, ok, so, you take the tax savings also, reinvest them further, so your wealth is larger.
In our example, under plan A, how much would the total amount you can reinvest be?

#4

Yup, pretty much that. You’re harvesting your tax loss by offsetting your gains with losses meaning you have more to invest today compared to if you simply paid tax on the gain and loss separately. In this particular example, the new cost base is lower and the value of the asset increased which means that the next year’s taxes is higher. I think the general point of this is that with tax loss harvesting, you save money today, freeing up cash to invest instead of paying it right off the bat to the tax man. You could also possibly benefit in the future if future cap gains tax rate is lower…or get screwed if it’s higher hehe. Hope this helps.

#5

Yes :relieved: thank you both fino abama and tomi!

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#6

Market value of Stock Y = 220,000 - 45,000 = CLC 175,000
Tax Savings = 20% \times 45,000 = CLC 9,000

Total amount reinvested (under Plan A; without reinvesting tax savings) = CLC 175,000

Total amount reinvested (the right way of using tax-loss harvesting strategy)
= CLC 175,000 + CLC 9,000 = CLC 184,000

#7

Thanks, Fino!

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