If you follow our US Expat Taxes Explained series, you are familiar with our sharing of important advice for US expats who live abroad. With the markets being particularly volatile this past year, we want to pass along a piece of tax planning wisdom from wealth management specialists Creveling & Creveling. On November 1st, Creveling & Creveling published an article on the following topic: “For U.S. Expats: Tax Loss Harvesting – A Strategy for Volatile Markets.” Today, we want to highlight some of the most important aspects from Creveling & Creveling’s article in order to turn any losses you may have had this year into savings on your US expat taxes.
“By realizing your losses and offsetting them against realized investment gains and other income, you can reduce your current year U.S. tax burden, defer tax, and even boost your portfolio returns through a process called tax-loss harvesting (TLH).”
What is Tax-Loss Harvesting?
The idea of tax harvesting is making up for losses you may have experienced over the year on your US expat taxes. Let’s say, for example, that you are invested in Vanguard’s Emerging Market ETF (VWO). Due to recent issues about the problems in Europe, the value has dropped and you are sitting on a $10,000, short-term loss. You also have capital gains of $5,000 for the year, and you are taxed at 35%. You would now have a tax liability of $1,750 for your capital gains, which is where your loss comes into play on your US expat taxes. If you sold your shares in VWO and bought into another fund that is not “substantially identical,” such as iShares MSCI Emerging markets Index (EEM), you would have realized your $10,000 loss and could use it to offset your $5,000 short-term gains, saving you $1,750 on your taxes. In addition, you now have $3,000 of the losses (each year) to offset ordinary income, saving another $1,050. The last $2,000 can use the next year against capital gains or ordinary income. While you may have realized a $10,000 loss, you save $2,800 on your US expat taxes not including the benefit of the $2,000 carried forward against your capital gains or income. Better yet, your portfolio is just as diverse as it was before you went through with tax-loss harvesting.
Rules for US Expat Taxes
“As with anything dealing with the IRS, there are a number of rules and caveats. The most important are:
- Wash Sale Rule: The IRS disallows the recognition of a loss on the sale of a security if the same or “substantially identical” security is bought within 30 days before or after the sale. The period subject to the wash sale rule extends 61 days, 30 days on either side of the sale including the sale date.
- Substantially Identical: Substantially identical means the same stock, fund or ETF, different classes of the same security, and options/ contracts on the same security. Funds or ETFs with the same underlying exposure and percentage holdings are likely to be considered substantially identical.
Selling Coke and buying Pepsi is fine. Selling Vanguard’s S&P 500 fund and buying Vanguard’s Large cap fund is probably fine. Selling Vanguard’s S&P 500 fund and buying Fidelity’s S&P 500 Fund is probably pushing it. Always check with your tax advisor.”
The information provided from the UBS AG case has proved to be a gold mine for the IRS. They can use this as a map to find what other accounts have been created elsewhere overseas. This information, in addition to policies such as the Foreign Account Tax Compliance Act signed last year, have given the IRS motivation to search for these undisclosed accounts. Other countries, such as Germany, the UK and Ireland, have also passed laws aimed at tax evasion.
When Does Tax-Loss Harvesting Not Work?
There are some important things to remember when it comes to making use of tax-loss harvesting on your US expat taxes. Here are some things to be aware of, as well as some tips.
- Tax-loss harvesting must be on taxable accounts (no 401 (k)s), not to mention that trading your IRA or 401(k) could break the wash sale rule.
- If you reinvest dividends and distributions, you may also break the wash sale rule. It’s best not to redistribute these distributions if you are going to apply tax-loss harvesting on your US Expat Taxes.
- You cannot offset distributions from capital gains.
- Look for these opportunities throughout the year, not just when it comes time to file your US expat taxes.
- Short-term and long-term gains need to be matched to each other first. Any additional overflow can then be used to offset current long-term gains, then short-term gains.
Expat Tax Advice About Tax-Loss Harvesting
We have couple of blog posts worth taking a look at: Read our tips about how to save money when filing your US expat taxes and then determine whether or not you need to file US expat taxes. Also, here is the entire Creveling & Creveling article on tax-loss harvesting. If you are considering tax-loss harvesting on your US expat taxes or would like expat tax advice, please contact us.