Tax Loss Harvesting: The Post-Sale Strategy That Requires No Advanced Planning

An unsolicited offer on your business comes in for $10,000,000. Congratulations! Then you sit down and realize that you’ll owe a substantial amount in taxes and the most commonly used tax saving strategies are off of the table because your sale is going through this month. What can you do?

While the best tax planning is proactive, you’re not out of options.

On our last blog, we discussed Qualified Opportunity Zones, which are available after a sale is completed. On this blog we’re going to discuss a second strategy, that’s possibly the most flexible strategy of them all – Tax-Loss Harvesting.

What is Tax-Loss Harvesting?

Tax-Loss Harvesting refers to a process where an investor sells a stock that they own at a loss and rebuys a similar, but not substantially identical security, and books that loss on their tax return while still maintaining their existing investment outlook.

Put simply, the benefit of tax loss harvesting is that an investor can take a loss while still generating gains in their investment portfolio. Pretty nice, right?

How does Tax Loss Harvesting Work?

Here’s an example of how Tax-Loss Harvesting could work if you owned Apple.

• Your Apple stock is at a loss. Let’s assume that you have Apple stock with the  following characteristics
  
  • Purchase Price - $200
    
    • Current Price - $175
      
      • Unrealized Loss – ($25)
• You then sell Apple and lock-in the following:
  
  • Realized Short-Term Loss of ($25)
• You then buy $175 of QQQ, the NASDAQ 100 ETF, to replace the Apple in your portfolio and maintain a similar investment strategy to what you previously employed
• While NASDAQ shares some of the same profile as Apple, it is not substantially identical as it comprises 100 positions, not just Apple.

When you’re doing this, there is one major rule that you need to consider – the wash sale rule. The wash sale rule states that you can’t purchase a “substantially identical” security within 61 days of your sale – 30 days before, the day of the sale, and 30 days after the sale. For a more detailed breakdown, checkout our in depth tax-loss harvesting blog.

How Tax Loss Harvesting Helps Business Owners

On its own, Tax-Loss Harvesting can provide substantial tax benefits to investors. However, the real magic happens when you combine tax loss-harvesting with a business sale. To apply tax-loss harvesting to a business sale, you need to tax-loss harvest systematically. This is where tax-loss harvesting can create significant tax-savings for business owners.

A systematic tax-loss harvesting strategy means that your entire account is geared towards generating tax losses (while still achieving market returns). Oftentimes, this is done by choosing an index to replicate and then building your account out of hundreds of positions instead of 1 ETF. By doing this, you create flexibility to generate tax losses.

The losses that are generated by the systematic tax loss harvesting account are capital losses. This means that you can offset the capital gains from the sale of your business with your investment account. As always, this only applies to capital gains. If you have ordinary income coming to you as part of your sale, that can’t be offset.

The best part about this is that the systematic tax loss harvesting account can be set up before or after the sale.

How Tax Loss Harvesting Can Help the Daniels

Throughout our series on how to save taxes on the sale of our business, we’ve followed the Daniels, a married couple living in Georgia who are looking to sell their $10,000,000 engineering business that they have $500,000 of basis in.

There are several different types of tax loss harvesting available. Sophisticated tax loss harvesting strategies can generate significant losses in volatile market conditions, though results vary widely based on market performance and timing. We’ll use one of the more advanced strategies that may generate ~32% in losses the first year that you invest. Let’s assume the Daniels invest 100% of their proceeds into the strategy. Here’s how those numbers look:

As you can see, investing in this tax loss harvesting strategy resulted in ~$3.2m of capital losses. These losses then offset their gains from the business and result in ~$800k in saved taxes.

The best part is that since this investment is completely unrelated to the business sale, they don’t have to worry about timing this with the sale. In the event the Daniels were sitting on extra cash before the sale, they could also invest in the strategy before the sale. Imagine if they could generate those losses for a couple of years and carry them forward on their tax return? They could then use all of those banked losses against their business sale!

Tax Loss Harvesting is by far the most flexible of the strategies that we’ve discussed, but even a strategy that doesn’t require proactive planning benefits from it!

What is Required to Setup a Tax Loss Harvesting Account?

• There may be account minimums
• You must follow the wash sale rules
• You will need a 3^rd party manager to trade these positions systematically

When do I need to setup my tax loss harvesting account?

• Because the account is not linked to the sale, there is no requirement that the account be set up before the sale.
• However, results can improve if it is set up prior to the sale.
• Finally, the earlier in the year the better. The actual losses will fluctuate with the market, and you will have better results if you start in January than December.

What problems can Tax-Loss Harvesting Cause?

• Tax Loss Harvesting is subject to market movements. It may generate more or less than the average returns you expect to see.
• You won’t know the final result until the end of the year.
• It won’t work as effectively if you sell your business later in the year
• You may pay taxes if you sell the investment account at a later date.

Who is tax loss harvesting best for?

Tax Loss Harvesting is best for business owners who want to maximize their flexibility with minimal lockups and legal/administrative costs. They also benefit those who may not have much time before a sale.

Personally, this strategy is one of my favorites due to the flexibility and lack of lockup periods related to it, because we all know life is going to change.

How Ironclad Wealth Management Customizes Your Strategy with Tax Loss Harvesting

Tax Loss Harvesting is simply one tool in the toolbox. While a tool is nice to have, knowing how to use it is key to generating the best outcome. When it comes to planning for the sale of a business, combining multiple strategies can yield the best result.

Ironclad Wealth Management helps business owners analyze the options available and create a plan that helps them reach their goals and save taxes in the most efficient manner possible.

Schedule a Consultation to get a personalized analysis of how tax loss harvesting can help you offset the taxes on your business sale.

Want to Keep Reading more about saving capital gains on your business sale? Check out our blogs on Asset vs. Stock Deals, Installment Sales, Structured Installment Sales, Qualified Opportunity Zone Funds, Charitable Remainder Trusts, Employee Stock Ownership Plans (ESOPs), and Qualified Small Business Stock Exclusions (QSBS).

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