Tax-Loss Harvesting: An Important Tactic Every Dermatologist Should Consider

Nearly every dermatologist wants to improve their after-tax investment performance. One tactic to do so is called tax-loss harvesting. Many dermatologists have heard this term but may not understand what it means or when it should be applied. In this article, we will describe this tactic in some depth, including using a dermatologist case study.

Kittiphan/Adobe Stock

Background on Tax-Loss Harvesting

Tax-loss harvesting occurs when an investor sells an investment at a loss to offset current or potential future gains on other investment positions. The result is that they pay tax on only the net amount of those gains/losses from positions sold, thereby lowering or even eliminating their taxable gain for the year. Often, the proceeds of either the assets sold for a loss or for a gain are then reinvested in a similar fund or asset class to keep the overall portfolio in its proper allocations.

The benefit of this strategy is reducing taxes; the higher a dermatologist’s personal income tax bracket, the greater the opportunity is for tax-loss harvesting. As many dermatologists are in the higher-income tax brackets, they will typically pay a 20% long-term federal capital gains tax as well as the 3.8% net investment income tax. Physicians will also pay a state income tax on the net gains (unless they live in one of the few other states without a state income tax). For those in states with the highest state tax rates, this can add another 10% or more to their total tax liability.

To properly execute loss harvesting and reinvestment properly, without running afoul of Internal Revenue Service rules, it is crucial that one works with a professional adviser experienced in these matters.

The Tax Rules

According to tax rules, these trades are allowable as long as you avoid the wash-sale rule. According to the Securities and Exchange Commission, a wash sale occurs when you sell or trade securities at a loss and within 30 days before or after the sale you:

• Buy substantially identical securities;
• Acquiresubstantially identical securities in a fully taxable trade; or
• Acquire a contract or option to buy substantially identical securities.

This Tactic Is Year-Round and Applies in Up and Down Markets

Many investors, both physicians and nonphysicians, wrongly assume that they should examine ways to reduce taxes on their investments only at the end of the year, when they know how they’ve done in terms of income and investments. Similarly, many operate under the assumption that tax-loss harvesting is primarily relevant when asset values are up and any asset sold may incur gains.

In 2020, for example, if an investor waited until the fourth quarter to harvest gains and losses, they would have missed the chance to take advantage of large tax losses early in the year. The tremendous opportunity to enjoy this win-win situation had come and gone by midyear. At one point in late March 2020, the S&P 500 was down over 34% year to date. By the end of the year, however, the S&P 500 rested well above a positive 10% return. If you waited until year end to realize losses, then you missed out on the potential to deploy this strategy. We see this reality in the case study below.

Real-World Case Study

The following case study provides a real-world illustration of tax-loss harvesting in action:

In March 2020, during the initial panicky days of the COVID-19 pandemic, Advisor Firm Alpha made trades in almost all its clients’ taxable accounts, realizing substantial losses. Alpha had an emphasis on the firm’s international equity and emerging market equity actively managed mutual funds, and therefore targeted replacement funds in those asset classes that would avoid any wash-sale issues.

Focusing on one physician’s portfolio, the Alpha team:

• Sold all holdings in an Emerging Markets Equity Fund, valued at $619,000, but initially purchased for this client in late 2014. This transaction realized a total loss of $94,000.
• On the next trading day, the Alpha team purchased $619,000 of a different actively managed Emerging Market Equity fund.
• As of December 31, 2021, that position was up 64% and was valued at $1,014,000.

In this way, the physician investor was in an ideal position—up significantly in that segment of her portfolio yet retaining an almost 6-figure loss for tax purposes. Further, if the doctor didn’t utilize all the losses in 2020, the net amount could be carried forward for future tax years.

One of the key success factors for this strategy to work as it did in this case study is for the investment manager to have identified and researched replacement funds in the target sector before the opportunity to make the trades arose. Disciplined, dispassionate investment research cannot happen the day of a trade—it needs to be done over time and well in advance of the transaction. Ideally, a physician’s adviser will continually curate a list of potential attractive replacement funds and keep them at the ready for a chance to deploy a tax-loss harvesting strategy. When the targeted fund is sold to harvest the loss, the adviser is confident of where the sale proceeds can be invested. This was the case for the Alpha team in 2020.

Conclusion

Tax-loss harvesting should be part of every astute investor’s game plan. Of course, one needs to understand the tax rules to implement these tactics properly, and a professional adviser can add significant value in this endeavor. Further, as the case study demonstrates, tax-loss harvesting is ideally a year-round process that can be applied in both up and down markets, allowing the investor to take advantage of opportunities as they arise.

David Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors, including Wealth Planning for the Modern Physician. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).

Adam Braunscheidel, CFP, is a wealth adviser. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosure

OJM Group, LLC (“OJM”) is a US Securities and Exchange Commission (SEC)–registered investment adviser with its principal place of practice in the state of Ohio. SEC registration does not constitute an endorsement of OJM by the SEC nor does it indicate that OJM has attained a particular level of skill or ability. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact practice in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. For information pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure website www.adviserinfo.sec.gov.

For additional information about OJM, including fees and services, send for our disclosure brochure as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money.

This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice or as a recommendation of any particular security or strategy. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently; accordingly, information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.