Tax-loss selling (or tax-loss harvesting) is a strategy that investors can potentially use to minimise their net capital gains during the financial year, for tax purposes. 

In a recent poll conducted by Sharesight, 45% of Australian investors stated that they planned to use a tax-loss selling strategy to offset their capital gains this financial year. 

While this strategy can be used by investors at any time, it is most commonly implemented towards the end of the financial year.

In Sharesight’s opinion, this makes June a good time to evaluate your investment portfolio and decide whether to use tax-loss selling to help offset any capital gains you incurred during the financial year.

This article explains how tax-loss selling works, the potential benefits and risks, plus important information you need to know before implementing this strategy. 

[Editor’s Note: Do not read the following information as a recommendation to implement a tax-loss selling strategy. Do further research of your own or speak to your accountant about whether such a strategy suits your needs, and any potential risks. Tax-loss selling can be complex and taxation laws prohibit certain types of tax-loss selling. Tax-loss selling also involves selling shares, which has other portfolio implications. Typically, investors chose to buy or sell shares based first on their investment merit, with tax-loss selling a secondary consideration.]

What is tax-loss selling?

Tax-loss selling involves selling investments that have incurred capital losses, in order to offset any capital gains realised during the financial year. By doing this, you could potentially reduce your taxable income. 

Therefore, if you wish to sell out of unprofitable stocks in your portfolio, you may consider using tax-loss selling to alleviate some of your losses while also rebalancing and realigning your portfolio with your investing strategy – even if the net effect is still negative. 

An example

Let’s say you bought 500 shares of Stock A a few years ago, when the price was $30 (purchase value, $15,000). Today, the stock trades at $300, meaning its value has increased by $135,000, in this example.

At some point, you also bought 500 shares of Stock B when the price was $100 (purchase value, $50,000). Since then, the share price has gone down to $50, decreasing your investment’s value by $25,000. 

Source: Sharesight
 

While you could hold onto Stock B in the hope that its share price will recover, you could also sell both Stock A and Stock B before the end of the financial year to offset some of the gains from your sale of Stock A with your sale of Stock B. 

Doing so may not only soften the impact of the loss, but it could also be an opportunity to shed an unprofitable stock (Stock B) and rebalance your investment portfolio. 

Factors to consider  

When considering tax-loss selling, it’s worth noting that the amount of money you save in taxes will vary according to your tax rate (individual/trust, Self-Managed Superannuation Fund or company). 

You should also be aware that you will be taxed at a higher rate for investments you’ve held for less than 12 months (short-term capital gains) compared to investments you’ve held for more than 12 months prior to selling. 

Choosing your sale allocation method

The Australian Taxation Office (ATO) allows you to choose which method is used to dispose of your shares, enabling you to determine your optimum tax position. This is especially useful if you have bought multiple parcels of shares in the same stock. 

You can choose from the following sale allocation methods: 

• First in, first out (FIFO): The longest-held shares are sold first. 
  
• Last in, first out (LIFO): The most recently-purchased shares are sold first. 
• Maximise gain: The shares with the lowest purchase price are sold first. 
• Minimise gain: The shares with the highest purchase price are sold first.
• Minimise capital gains tax (CGT): Shares that will result in the lowest CGT will be sold first. 
   

Benefits of tax-loss selling

As mentioned above, the key benefit of tax-loss selling is the ability to potentially reduce your taxable income by decreasing your capital gains tax on shares. 

This strategy can also be a potential way to optimise your investment portfolio by shedding unprofitable stocks that you don’t expect to recover. By doing so, you could potentially increase your future gains by reinvesting in assets that you believe have better prospects. 

In general, this strategy could be beneficial if you have a hard time selling your losing stocks, and could potentially help prevent further losses in that stock [if they occur].

Risks of tax-loss selling 

While tax-loss selling can be a useful investing strategy when implemented effectively, it does carry some risks. For example, as much as it can help you shed losing stocks, there is also the risk that you may sell off stocks prematurely, causing you to miss out on potential future gains. 

In a similar vein, when you sell assets at a loss, there is the risk that should you eventually wish to repurchase the same or similar assets, you must do so at a higher price – resulting in increased costs and lower returns. 

Key risk: avoiding wash sales

It’s important to note that in 2008, the Australian Taxation Office (ATO) issued TR 2008/1, a taxation ruling that forbids arrangements where “... 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”. 

Essentially, this means that the ATO does not allow investors to sell a stock in one financial year, taking advantage of the capital-loss event, only to buy the same stock again in the following financial year. This is referred to as a “wash sale”, and the ATO will invalidate the loss if the sole intention of the sale was to avoid tax. 

As Sharesight Executive Director Andrew Bird says: “If you are going to sell, make sure you really mean it. If you still believe in that stock, then choose a different ‘loser’ to sell, to offset your gain.”

Conclusion

If you’ve made some capital gains this financial year, tax-loss selling can potentially be a strategy to help you shed unprofitable stocks and offset your losses. 

That said, attempting to model your tax-loss selling opportunities can be a cumbersome process, especially when done manually via spreadsheet. 

This process is made easier by using an online portfolio tracker such as Sharesight, which has an unrealised capital gains tax report specifically designed to help you model different tax-loss selling scenarios in your portfolio. Not only is this a more convenient (and accurate) way to model your tax-loss selling opportunities, but it can also help you save time and money at tax time. 

DISCLAIMER

This article is for informational purposes only and does not constitute a specific product recommendation, or taxation or financial advice and should not be relied upon as such. While we use reasonable endeavours to keep the information up-to-date, we make no representation that any information is accurate or up-to-date. If you choose to make use of the content in this article, you do so at your own risk. To the extent permitted by law, we do not assume any responsibility or liability arising from or connected with your use or reliance on the content on our site. Please check with your adviser or accountant to obtain the correct advice for your situation.