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TD Ameritrade

Tax-loss harvesting

A look into how this service by TD Ameritrade Investment Management may benefit you

Introduction

How can tax-loss harvesting potentially benefit you?

Is tax-loss harvesting right for you?

You can potentially benefit from a tax-loss harvesting strategy if…

You may not benefit from tax-loss harvesting if…

Our solution

Eligible accounts

Account funding minimum

Our trading process

Replacement security

How to identify harvested losses

How to enroll

The wash sale rule

What happens if I do violate the wash sale rule?

Definitions

Key takeaways

Tax-loss harvesting is designed to reduce your tax bill each year

We offer an automated tax-loss harvesting strategy designed to help offset tax consequences from successful investing

You can use harvested losses to offset taxes on any capital gains as well as to reduce taxable income by up to $3,000 per year

Investing the money you save on taxes can contribute to additional portfolio growth

TD Ameritrade Investment Management ("TDAIM") offers automated tax-loss harvesting in its ETF-based portfolios at no additional cost

Introduction

Many investors struggle to understand the complexities of investing, from investment selection and rebalancing to effective tax management. TDAIM can help with the addition of our tax-loss harvesting service.


Stated very simply, tax-loss harvesting is selling an investment that has lost value and purchasing a replacement security . Then, the investment loss can be used to reduce the taxes you pay on investment gains you might have, or to reduce your other taxable income.


Using a tax-loss harvesting strategy allows your money to stay more fully invested and working towards your long-term investing goals. In addition, you can invest any tax savings into your portfolio, allowing for greater potential benefit to you.

Traditionally, tax-loss harvesting has been used by sophisticated investors managing their own portfolios or by high-priced financial advisors who handle tax-loss harvesting for their wealthy clients. TDAIM makes this complex strategy available to all of its clients who hold the minimum balance in our Essential Portfolios and Selective Portfolios investing in ETFs, at no additional cost.


How can tax-loss harvesting potentially benefit you?


When you file your income taxes, you can use any realized capital losses to offset any realized capital gains you might have taken during the tax year, minimizing the tax liability associated with those capital gains.


If you don’t have any capital gains or if you have more losses than gains, you can use the losses to offset up to $3,000 of other taxable income per year. If any harvested losses still remain, you can roll them over, helping you to lower your tax liability in future years. Included below is a simplified example of how tax-loss harvesting might benefit you.

Is tax-loss harvesting right for you?

Tax-loss harvesting can be helpful to many investors, but it’s important to understand some situations that can make you a good candidate for this strategy. Below, we’ve outlined a few typical situations to help you better understand tax-loss harvesting. However, tax-loss harvesting is not appropriate for all investors and, as with all tax-related questions, we encourage you to speak with your tax advisor to review your specific tax situation.

You can potentially benefit from a tax-loss harvesting strategy if:

As we mentioned earlier, the benefit of tax-loss harvesting is the ability to realize losses in your portfolio and then offset any realized capital gains you take across all your investments. For example, tax-loss harvesting can be helpful in a tax year where you plan to sell an investment property, business, or other investment where you might have a large capital gain. When you choose to enroll in our tax-loss harvesting service, TDAIM reviews your portfolio on a daily basis to look for tax-loss harvesting opportunities, which means you can realize losses throughout the year that might not necessarily be available at year-end. This may further help you to offset capital gains.

Tax-loss harvesting may help reduce the potential income tax you have to pay. If you are currently in a higher tax bracket, you can use realized capital losses for three purposes:

1. Higher income earners can currently pay up to a 23.8% tax rate on realized long-term capital gains. If you leverage tax-loss harvesting, you can use realized capital losses to reduce your total amount of realized capital gains, which would lower your tax bill.

2. If you don’t have capital gains in any given year, you can still benefit by using your realized capital losses to reduce up to $3,000 of taxable income per year.

3. After using your losses to offset capital gains and income, you can use any remaining losses to offset gains or income in later years.

If you desire to distribute most of your investments to heirs or charities, you may further benefit by participating in tax-loss harvesting. If you donate investments or pass them on to heirs, you may wish to gift highly appreciated investments and, for any other investments, participate in tax-loss harvesting to further reduce your tax bill.

You may not benefit from tax-loss harvesting if:

If you are in the 10% or 15% tax bracket, you currently pay a 0% tax on long-term capital gains and would not benefit from tax-loss harvesting.

While Essential and Selective ETF Portfolios are designed for long-term investors, if you already have plans to make withdrawals from your portfolio or to change your personal risk preference in the near future, tax-loss harvesting may not be the right fit. While our system is designed to minimize any risk of violating the IRS wash sale rule, on an individual account level, we also prioritize any trade instructions that you provide to us. For example, if you request to liquidate your portfolio, TDAIM will enter the transactions per your instructions regardless of any potential tax consequences that might occur.

You may run the risk of violating the wash sale rule if you or your spouse hold the same investments in another brokerage account that you hold in your eligible TDAIM portfolio and you regularly trade these investments. As a part of our tax-loss harvesting service, we only review our managed ETF portfolios and we do not review any of your other accounts at TD Ameritrade or elsewhere.

If you are only investing in a tax-deferred account, like an IRA or 401k, a tax-loss harvesting strategy is not appropriate for you since your investment earnings, dividends, and interest are already tax-deferred.

Our solution

Eligible accounts

The TDAIM tax-loss harvesting service is available only for taxable account types. Taxable accounts are those on which you pay taxes on any dividends, interest, and realized investment earnings each year. Taxable accounts include individual, joint tenants with rights of survivorship, and joint tenants in common, among others.

On the other hand, account types that many investors use for retirement investing are not eligible for our tax-loss harvesting service. Examples include IRAs, Roth IRAs, and 401(k)s. In these accounts, you don’t pay any taxes on dividends, interest, or investment earnings each year; therefore, using a tax-loss harvesting strategy in these account types would not provide any benefit to you.

At this time, our tax-loss harvesting service is only available in our ETF-based portfolios.

Account funding minimum

You're eligible to enroll in tax-loss harvesting if you meet the minimum funding requirements for Essential or Selective ETF Portfolios in taxable accounts.

You should be aware that based on our trading logic for tax-loss harvesting, accounts funded near the funding minimums may not see as many tax-loss harvesting opportunities. However, as a particular investment meets our criteria for tax-loss harvesting, TDAIM will execute the trades in any enrolled account.

Our trading process

Every day, TDAIM will review your account for investments that have lost value beyond a certain threshold. Specifically, TDAIM looks at the individual tax lot and determines if the loss amount is significant enough before placing a tax-loss trade.

So what exactly is a tax lot? As you add money to your portfolio or as rebalances occur over a period of time, you acquire different “lots” by purchasing securities. The individual transaction’s history is considered a tax lot.

As a part of our daily process, TDAIM will sell the investment that had a loss and purchase a replacement security to help you maintain your asset allocation while benefiting from the potential tax savings.

Your portfolio will stay invested in the replacement security unless any one of the following situations occur:

You ask us to liquidate your entire portfolio

You request to raise cash from your portfolio; for example, to distribute cash from your account (note: TDAIM will seek to reduce any position in a replacement security before selling any positions of primary holdings)

The asset class the ETF represents is no longer deemed appropriate for your portfolio

The individual replacement security no longer meets the criteria to remain in your portfolio

A tax-loss opportunity presents itself for that particular replacement security

You request to change to a different portfolio offered by TDAIM

A periodic rebalance of portfolio holdings occurs

Replacement security

TDAIM goes through a rigorous due diligence process to select securities to replace those sold for tax-loss harvesting purposes. We seek replacement securities that meet TDAIM’s high standards, keep your portfolio in line with its target allocation, and do not put you at risk for violating the wash sale rule. All of the replacement securities are reviewed on an ongoing basis to ensure the ETFs meet our high standards, such as:

Tracking error: We seek to invest in funds that closely track the index to which the fund is trying to provide exposure

Daily trading volume: We seek to invest in funds that offer high levels of liquidity to investors

Net expense ratio: We choose to invest in low-cost ETFs as much as possible

Average 12-month premium/discount: We purchase funds that are designed to maintain a tight relationship between the fund’s net asset value and its share price

How to identify harvested losses

You can review the trading activity in your account in multiple ways. Your trading history is available to you in real-time through our online secure website and is listed on your account statements. Also, at the end of each year, TD Ameritrade will provide you with an IRS Form 1099 tax document, which summarizes all of the investments that were sold in a particular year as well as any dividends and interest you might have earned. You will use this form to complete your taxes each year.

If you use online tax-preparation software like TurboTax, you can easily import your transaction history when you prepare your taxes.

How to enroll

You can enroll in tax-loss harvesting online after you’re logged in to your account or by giving our team of Portfolio Specialists a call. Once enrolled, TDAIM will manage the process for you, so you don’t have to. If you want to turn off the feature, you may do so at any time.

Understanding the wash sale rule

Investors should educate themselves about the IRS’ wash sale rule, described in IRS Publication 550. The rule prohibits you from claiming a tax loss if you repurchase the same security (or a substantially similar security) either 30 days before or 30 days after selling a security for a loss. To evaluate whether you violated the wash sale rule, the IRS reviews the trading activity for all of your accounts. In other words, the IRS looks at trades you place in other accounts at TD Ameritrade, at other brokerage firms, and in IRA or Roth IRA accounts, as well as transactions your spouse made and transactions by a business entity you control to determine if you violated the wash sale rule.

TDAIM's tax-loss harvesting service only scans your TDAIM portfolio on an individual account level (not all of your portfolios collectively) to reduce the chance of violating the wash sale rule in that particular account, and TDAIM does not have any transparency into your trading activity in brokerage accounts that you may have at TD Ameritrade or at other financial institutions. Therefore, a trade that TDAIM places in one account may inadvertently create a wash sale in another account. You should be aware of investments in all your investment accounts to determine if you run the risk of violating the wash sale rule.

What happens if I violate the wash sale rule?

If you violate the rule, the IRS will not allow you to claim the loss for that particular transaction. Additionally, the IRS will add the loss amount to your cost basis of the new security you purchased, which will reduce your ability to claim a loss in future years.

Definitions

Capital Gain: when an investment is worth more now than the original purchase price (the opposite of a capital loss)

Capital Loss: when an investment is worth less now than the original purchase price (the opposite of a capital gain)

Eligible Portfolio: portfolios eligible for our tax-loss harvesting service (available only for Essential Portfolios, Selective Core ETF Portfolios, or Selective Opportunistic Portfolios)

Realized: a capital gain or loss on a particular investment that has been closed out (i.e., sold) in a particular tax year (the opposite of an unrealized gain or loss)

Taxable Account: an account in which realized earnings, dividends, and interest are taxable each year (the opposite of a tax-deferred account, such as an IRA or 401(k) plan account).

Tax Lot: a transaction (buy or sell) in an individual security at a specific price and time

Unrealized: a capital gain or loss that is only on paper where the security has not been sold yet (the opposite of a realized gain or loss)

Wash Sale: when an investor sells an investment at a capital loss and repurchases the same security or a substantially similar one within 30 days (before or after) the original sale.

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