The Berserk Financial Markets Provide Opportunities for Tax-Saving Tactics

We are seeing the reactions to the COVID-19 (the coronavirus) spread across the globe. Italy is on lockdown. France’s Eiffel Tower is closed. Australia is going to ban all foreign visitors.

Here in the U.S., a large number of schools and colleges have closed. Toilet paper is in short supply—words I never thought I would say. (It will be restocked.) Restaurants are either closing, limiting patrons or only offering take-out and drive-thru service. Retirement communities are going into quarantine. (Visitors are no longer allowed at either my parents’ or my mother-in-law’s independent living facilities.) Travel has ground to nearly a halt. (All four of my spring trips, including the cruise I was supposed to take starting on Sunday, have been canceled.) Downtown Chicago has turned into a ghost town. My fellow AAII staffers and I are working remotely for the time being.)

All of this is affecting the global economy and thereby the financial markets. While the stock market has received most of the attention, things aren’t dandy in the high yield (aka, junk bond) or commodities markets either. The oil spat between Saudi Arabia and Russia is ongoing. The banking system is being stressed by small and large businesses drawing on their credit lines. The economic slowdown is raising questions about the ability of corporations with weaker credit ratings to stay within their debt covenants.

Even the municipal bond market has been incurring volatility. A recent Raymond James commentary listed the yield advantage between a 10-year municipal bond over a 10-year Treasury bond as being 72 basis points (0.72%). A week prior the same spread was just 12 basis points. There are concerns about the pandemic’s impact have on state and local governments, though the default rate among muni bonds is much lower than it is among corporate bonds.

With everything going on, I’ve been focusing these weekly commentaries on actions you can take in the current market environment. You can find them in the Investor Update archives. Today, I’m going to focus on the tax side and talk about tax-loss harvesting, which was the focus of Tuesday’s Weekly Digest email. I’ll also discuss the revised deadline for paying taxes.

Tax-loss harvesting involves intentionally selling an investment at a loss in a taxable account so you can lower your tax bill. Losses offset gains, with a net loss of $3,000 allowed to be claimed on your taxes for a single year. Any net losses above this amount can be carried over to future years.

A big key to tax-loss harvesting is to be cognizant of the wash-sale rules. You cannot sell an investment and claim a loss if you buy or otherwise acquire “substantially identical stock or securities” within a 30-day period. This includes selling an investment in your taxable account and quickly rebuying it in your IRA or Roth IRA. You need to wait 30 days to do so. (If you sold at a loss and then repurchased the same security within 30 days in a taxable account, the loss from the older position would carry over to the new position’s basis.)

Notably, it is possible to sell an exchange-traded fund (ETF) at a loss, buy its near-twin from another ETF sponsor and not violate the wash-sale rule. An example would be to sell the SPDR S&P 500 ETF (SPY) and buy the iShares Core S&P 500 ETF (IVV). Doing so would expose you to the risk of a rule change and/or an unfavorable ruling by the tax court. A more prudent step would be to buy a highly correlated, but different ETF such as swapping the SPDR S&P 500 ETF for the iShares Russell 1000 ETF (IWB). Buying the Invesco S&P 500 Equal Weight ETF (RSP) would be another option. In my taxable account, I recently harvested losses in the Fidelity ZERO Extended Market Index fund (FZIPX) and used the proceeds to buy shares in the Fidelity Zero Total Market Index Fund (FZROX).

It may also be worthwhile to harvest losses now for the purposes of adjusting your tax location. Tax location involves strategically placing your investments in the right type of account. Less tax-friendly investments—corporate bonds, REITs and less tax-efficient funds—should be held in tax-preferred accounts such as traditional and Roth IRAs. The same applies for high-turnover trading strategies. Tax-friendly investments—municipal bonds, stocks paying qualified dividends, master limited partnerships (MLPs)—should be held in taxable accounts.

If you do decide to move investments around, be cognizant of the wash-sale rules. If you sell at a loss, you will have to wait 30 days. You could park the money in an ETF until the 30-day period has expired—especially since commissions are now zero at most brokerage firms—to preserve your allocations. As is the case with any tax strategy, be sure to assess your personal situation and consider meeting with a tax professional if you have questions about the potential impact.

The Deadline for Paying, but Not Filing, Has Been Extended

This week, the Internal Revenue Service extended the deadline for paying taxes. Individuals who owe no more than $1 million in taxes can postpone payment from April 15, 2020, until July 15, 2020. The extension applies to both 2019 taxes and to estimated taxes for the first quarter of 2020.

The deadline for filing 2019 tax returns has not changed. You still must file your tax return or a request for an extension by April 15, 2020.

This IRS Notice contains more information.