Each June, investors begin to look ahead to the end of financial year and tax time. As the window shuts on one financial year, investors typically begin reorganising their share portfolios and preparing for their tax liabilities. Few strategies are more apparent than tax-loss selling, which is widespread throughout June in the lead-up to the end of the financial year.
Tax-loss selling is a strategy adopted by a wide range of investors to manage tax obligations, including those of individuals, fund managers and institutions. The purpose behind tax-loss selling is to reduce one’s net capital gains for the financial year. It involves selling shares that have incurred a capital loss, which may then offset capital gains realised throughout the financial year. In effect, the intent is to minimise tax owing from investing in shares.
Some investors have difficulty converting a paper loss into an actual loss, however, it is crucial to remove emotion from any investment decision in order to see the forest for the trees. What you once paid for a stock is not nearly as relevant as what benefit or opportunity is best moving forward.
How do shares perform amid tax-loss selling?
There is an old adage in the stock market that goes “sell in May and go away”. The premise behind this saying is that there is generally a sell-off in stocks throughout May and investing in shares doesn’t typically pick up until November.
Entering June, the month can sometimes be a case of things going from bad to worse for certain shares. In many instances, this is especially the case for underperforming stocks. This is because investors often look to exit shares that have underperformed the broader market throughout the financial year, instead investing in shares they believe might prove more ‘lucrative’.
It is not uncommon for micro or small-cap stocks to see persistent selling ahead of the EOFY. Sometimes, shares at this end of the market reach new lows due to a lack of liquidity that can prompt sellers to sell into the ‘bid’ out of concern their EOFY tax-loss sale might not get executed before June 30.
Even blue-chip favourites can be hit hard by the phenomenon when they underperform relative to their peers. This was evident in the likes of Telstra (ASX: TLS) and AMP (ASX: AMP) during June of 2018, despite the ASX rising 3% in the same month. Since 2002, however, the ASX has largely seen varying levels of returns ahead of the EOFY.
ASX returns in the month of June (*2020 data as at 15 June)
Considerations associated with tax-loss selling
While the merits of tax-loss selling will depend on each individual’s personal circumstances, there are some broader considerations that may be useful to ponder when investing in shares.
First things first, tax-loss selling is based entirety on your specific financial position. Looking for a designated list of stocks to sell is meaningless. The only stocks that are relevant for a tax-loss sale are the ones specific to your portfolio.
This is because your choices depend on what shares you own, their outlook, the prices you paid, the weight of said shares in your portfolio, as well as current paper profits or losses. Consider why you bought a stock in the first place and avoid a panicked decision made solely for tax reasons.
In addition, there is also the matter of one’s expected income and marginal tax rate. Both of these factors dictate the extent of any potential tax savings. In fact, it is possible to carry forward capital losses to subsequent financial years when they do not immediately offset a capital gain.
Secondly, there is a 50% capital gains tax (CGT) discount for assets held by individuals or trusts more than 12 months. The Australian Taxation Office (ATO) has detailed information about this on its website.
Thirdly, you may want to consider what you will do with the proceeds from the tax-loss sale. Some investors might need these funds for other commitments, whereas some investors will be inclined to continue investing in shares that come with less opportunity cost. Tax-loss selling may even encourage new investors or traders to buy a ‘beaten-down’ stock in hope of a recovery.
Finally, it’s also important to be aware of a very important provision put forward by the ATO. The ATO will disallow any capital losses where an investor has engaged in what is known as a “wash sale”. This type of action takes place when an investor sells a specific stock only to re-buy the same or a similar amount of shares in that stock a short time later.
Although the ATO does not specify an exact time period, there is little leeway for this practice if the ATO believes a tax benefit has been derived from a transaction that otherwise would not have been executed but for the sole purpose of minimising tax.
Tax-loss selling isn’t limited to June. At any time throughout the year, one might consider crystallising a loss as part of this strategy.
However, due to wash sale provisions enforced by the ATO, any decision to pursue a tax-loss selling strategy should be one that is certain and definitive.
Nonetheless, the above considerations associated with tax-loss selling are a starting point for investors to weigh up. Always consult an accountant to understand how your personal financial circumstances apply.
SelfWealth Ltd ACN 52 154 324 428 (“SelfWealth”) (Australian Financial Services License Number 421789). The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser. Taxation, legal and other matters referred to on this website are of a general nature only and should not be relied upon in place of appropriate professional advice.