What is Tax-Loss Harvesting?

In simple terms, tax-loss harvesting involves the selling of securities when the investments sustain a capital loss. These losses are used to offset their value from the income in tax returns for that year. Similarly, the sold asset can be used to offset investment gains. Usually, the implementation of tax-loss harvesting occurs towards the end of the fiscal year. Investors can also harvest it at any time during the tax year. Later in this piece, we will look at how tax-loss harvesting in Australia works.

Tax-loss harvesting is an important facet in reducing taxes. While it cannot restore the investor to his/her previous standpoint, it could lessen the blow suffered by the loss.

Additionally, an important aspect of tax-loss harvesting is the potential risk of wash sales and buybacks. Wash sales occur when an investor sells securities or stocks at a loss to offset the tax from capital gains or income. While a buyback occurs after a wash sale when the investor repurchases substantially identical stocks.

Tax-loss Harvesting in America

In the United States, under the American tax law, investors are able to offset their capital gains with the losses sustained in that tax year. This law allows them to reduce their tax bills.

For example, Kevin has Security A and Security B. Security A garnered a profit of $50,000 while Security B suffered a loss of $20,000. Through selling Security B, Kevin is able to offset his capital gains from Security A. This means Kevin would owe taxes for only $30,000 of his profit instead of $50,000.

The buyback rule in the United States identifies that if a wash sale (investment sold at a loss) is repurchased within 30 days, the initial loss cannot be claimed. This means the tax-loss harvesting for capital gains or income cannot be implemented. Investors must adhere to a minimum of 31 days before repurchasing similar securities. More on the US circumstances here.

An Overview of Tax-loss Harvesting in Australia

As defined earlier, tax-loss harvesting is a strategy investors can implement to reduce their net capital gains during the fiscal year. In Australia, the end of the financial term in June will mark the best time to make any decisions regarding tax-loss harvesting.

Contrary to the United States, Australian tax laws have been vague and unclear. To elaborate, up until 2008 Australia did not possess a detailed buyback rule. However, the anti-avoidance provisions in Part IVA of the Income Tax Assessment Act (ITAA) 1936 was used instead. This system was liable to certain investors interpreting it in a way that benefited them.

The Australian Buyback Rule

In 2008, the Australian Tax office put out a ruling that banned the misuse of tax-loss harvesting. TR 2008/1 states “…in substance, there is no significant change in the taxpayer’s economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer”. This does not provide a specific time period, instead vaguely limits buyback to a short time frame. So this is left up to interpretation.

The TR 2008/1 bans the claiming of any tax benefit from selling a security before it is repurchased. As well as entering into repurchase deals with other parties such as relatives and transactions between investors and a trusted company.

The penalty issued for the breach of this ruling is often up to 50% of the tax that has been avoided.

A tax specialist should be consulted before implementing any of this to your personal circumstances.