Tax Harvesting by Fidelity

Most Investors Could Use Simple Tax-Wise Strategies

to Reduce Their Tax Bills

Are You Missing Out on Lower Tax Bills?

REPORT

ThE FidEliTy REsEaRch insTiTuTE

is designed to advance knowledge of

how proven investment theory and public

policy can be put into practice to help

americans invest wisely to meet their

financial needs. The institute calls on

resources across Fidelity investments

as well as within the financial services

industry and academia to accomplish

its mission.

overviewWith the tax season rapidly drawing to a close—and, with it, the ability for millions of Americans to reduce their tax bills—the Fidelity Research InstituteSM has completed a new study that shows the majority of investors are missing out on a simple tax-wise strategy that can lower their income taxes due on April 15. In many cases, these investors could significantly lower their Federal tax bills by simply selling any stock, bond and/or mutual fund positions that are currently at a loss compared to their original purchase price.

The Institute’s analysis shows that a majority of investors in the study—and arguably millions of Americans across the country—are not “harvesting” these loss positions to their advantage. In addition, a significant number of individuals who do take these losses for tax purposes subsequently fail to capture the immedi-ate tax benefit because they repurchase the same securities they sold at a loss

ReseaRch InsIghts

December 2006

By: W. Van Harlow, Ph.D., CFA Managing Director Fidelity Research InstituteSM

James Laiosa Senior Quantitative Analyst Fidelity Research InstituteSM

within 30 days, thereby creating a “wash sale” for tax purposes.

This report presents key findings about who is missing out on this tax strategy and the impact it is having on their tax bills. It also offers guidance on how to take advantage of this harvesting opportunity. Investors must take action on or before the last trading day of the year in order to take advantage of losses for the current tax year.

Fidelity research institute

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ReSeARch ShoWS

ThAT The MAjoRITy

oF InveSToRS MISS

ouT on ThIS TAx-WISe

InveSTIng STRATegy

selling loss Positions for Tax BenefitsAnnually, millions of investors have the opportunity to sell any equity, fixed-income

or mutual fund position that may be valued at less than what they bought it for and

harvest that loss to their benefit when they file their income taxes. These losses can

be used to offset capital gains investors may have from other positions. Additionally,

if losses are greater than an investor’s capital gains, he or she likely will be able

to deduct a net loss of as much as $3,000 a year from wages and other ordinary

income. Moreover, any net loss greater than $3,000 in one year can be rolled over

to benefit future tax years.

The Fidelity Research Institute believes that each year investors should sell any

of their loss positions for tax benefits and reinvest those assets immediately

to keep their portfolios on appropriate track (although not in the same security

in order to avoid a wash sale).1 Research shows that the majority of investors miss

out on this tax-wise investing strategy. In an analysis of data for a random sample

of approximately 185,000 households with taxable accounts served by Fidelity

Brokerage company, the Institute found that 67% of households for the 2003 tax

year did not take full advantage of their unrealized losses. of the 252,000 taxable

accounts held by these households, the Institute found that about 26% of the

households had sufficient losses to take full advantage of the $3,000 maximum

allowable deduction. Another 41% missed harvesting some of their losses. only

10 percent of the households actually took full advantage of the $3,000 maximum

ordinary deduction allowed under the tax code (see Exhibit 1).2

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exhibit 1

tax loss Harvesting

opportunity

Realized Losses Maximized

No Losses To Be Harvested

Missed Harvesting Some Losses

Missed Harvesting Maximium Losses

67% of households did not take full advantage of their unrealized losses

Realized Losses Maximized 10

No Losses To Be Harvested 23

Missed Harvesting Some Losses 41

Missed Harvesting Maximium Losses 26

23%

10%

26%

41%

67%

67% of households

for the 2003 tax year did not

take full advantage of their

unrealized losses.

source: Fidelity Brokerage company, Fidelity research institute


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Perhaps the failure of a majority of individuals to take advantage of this simple

strategy to reduce their tax payments can be explained by either investor inertia

or investor psychology that prevents them from selling a position at a loss.

In any case, even for the most deliberate buy-and-hold investor, harvesting loss

positions for tax benefits is one of the smartest and easiest strategies available

to investors holding positions in taxable brokerage or mutual fund accounts.

This tax strategy is not available for tax-advantaged accounts such as traditional

IRAs, Roth IRAs or workplace savings plans.

This easy action can yield a relatively sizable tax benefit. For example, consider

the simple case of an investor with a single position in a security or mutual fund.

Assume this individual had purchased this investment for a total of $30,000.

If this position is worth $27,000 today, there is an opportunity to sell it and secure

tax savings on this year’s tax return.3 If this household had a taxable income

of $100,000 and no other items of capital gain or loss, this harvesting of the

$3,000 loss ($30,000 value at purchase minus $27,000 at sale) would have

lowered their tax bill by $750.4

Exhibit 2 provides a breakdown of the tax loss harvesting opportunity in relation

to the number of positions within the accounts owned by households. grouping

households in this manner provides a proxy for the degree of investor involvement in

their ongoing portfolio management—presumably, the greater the number of securi-

ties and/or funds in an account, the greater the attention and involvement potentially

required and administered. In looking at this chart, it is apparent that considerable

tax loss harvesting opportunities were still available across accounts

of all position sizes. households with larger numbers of positions in their accounts

were more diligent on average, though even they did not come close to taking full

advantage of unrealized losses.

hARveSTIng loSS

PoSITIonS FoR TAx

BeneFITS IS one

oF The SMARTeST

And eASIeST STRATe-

gIeS AvAIlABle

To InveSToRS FoR

PoSITIonS held In

TAxABle BRokeRAge

oR MuTuAl Fund

AccounTS

5

exhibit 2

tax loss Harvesting

opportunity

by Number of

Positions per Household

1 2 3 4 5

TOTAL NUMBER OF POSIT IONS

6 to 1

0

More

than 5

0

21 to

50

11 to

20

PE

RC

EN

T O

F H

OU

SE

HO

LD

S

0%

20%

40%

60%

80%

100%

Realized Losses Maximized

No Losses To Be Harvested

Missed Harvesting Some Losses

Missed Harvesting Maximium Losses


One of the largest groups

missing out on tax savings

had between $25,000

and $500,000 in assets


6

Fidelity research instituteFidelity research institute

6


oldeR And MoRe

SeASoned InveSToRS

WeRe Found To Be

leAvIng TAx SAvIngS

on The TABle

In Much The

SAMe WAy AS WeRe

youngeR SAveRS

Although not presented here in full detail, similar results were found when the

analysis was viewed in conjunction with the total market value of accounts. In

other words, the overall dollar value of the account is an alternative proxy for

investor involvement in much the same way as the number of positions. households

with more assets were found to have done a better job on average at harvesting

than those with fewer assets, though there is ample evidence that individuals

with less than $25,000 in assets and those with more than $25 million in assets

still didn’t take the appropriate action. one of the largest groups missing out

on tax savings had between $25,000 and $500,000 in assets, where 73% of

the accounts did not maximize their harvesting opportunity.

When similar analysis was done based on ages of the heads of households,

no significant differences were found among age groups. older and more seasoned

investors were found to be leaving tax savings on the table in much the same way

as were younger savers.

While it is important to examine the number of missed opportunities across

households, it is also interesting to quantify the amount of foregone tax savings.

Exhibit 3 provides an analysis of the potential tax savings per household from

optimal tax loss harvesting based on the assumption for this exercise that all

households have a marginal tax rate of 35% for short-term gains and losses

and 15% for those that are long-term.5 As in exhibit 2, households are grouped

based on the number of securities and funds held in their taxable accounts.

As Exhibit 3 shows, most households could gain up to $500 in tax savings through

the simple recognition of tax losses prior to the end of the tax year. For example,

for households owning a position in only one particular security or mutual fund,

54% might have had tax savings of less than $100. however, 46% missed $100

to $500 in tax savings. At the other extreme, households with 50 or more positions

in their accounts, 47% had potential tax savings of between $0 and $1000,

but 53% had tax savings opportunities in excess of $1,000.

Most households could gain

up to $500 in tax savings

through the simple recognition

of tax losses prior to the

end of the tax year

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1 2 3 4 5


6 to 1

0

More

than 5

0

21 to

50

11 to

20

PE

RC

EN

T O

F H

OU

SE

HO

LD

S

0%

20%

40%

60%

80%

100%

TAX SAVINGS:

More than $5000

$1000 up to $5000

$500 up to $1000

$250 up to $500

$100 up to $250

Less than $100


exhibit 3

Potential tax savings by

Number of Positions per

Household


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avoiding Wash salesIn a different example of missing out on lower tax bills, the Institute also found

that 8% of investors forfeited their immediate tax benefit because they reinvested

in the same securities that they sold at a loss within 30 days, which created a wash

sale.6 Exhibit 4 displays the lost tax savings in relation to the number of positions

in the accounts. not surprisingly, accounts with more positions and sells have

a higher likelihood of inadvertently falling victim to a wash sale. In the case

of accounts with more than 50 positions, 30% of households experiencing

a wash sale forfeited an immediate tax savings in excess of $1,000.

AccounTS WITh MoRe

PoSITIonS And SellS

hAve A hIgheR

lIkelIhood oF

InAdveRTenTly

FAllIng vIcTIM

To A WASh SAle

9

1 in 12 households

forfeited their immediate tax

benefit due to wash sales.

1 2 3 4 5


6 to 1

0

More

than 5

0

21 to

50

11 to

20

PE

RC

EN

T O

F H

OU

SE

HO

LD

S

TAX SAVINGS:

More than $5000

$1000 up to $5000

$500 up to $1000

$250 up to $500

$100 up to $250

Less than $1000%

20%

40%

60%

80%

100%

exhibit 4

tax Savings Forfeited

from wash Sales



10


TAx loSSeS cAn Be

uSed AS TAx SAvIngS

FoR The cuRRenT oR

FuTuRe TAx yeARS

CoNClUSioN

Investor inaction with respect to tax loss harvesting just discussed—and inappropri-

ate action with respect to wash sales—highlight the need for closer attention to

the details of managing one’s investments to ensure that tax losses can be used

as tax savings for the current or future tax years. Beyond the $3,000 maximum

allowed deduction on each year’s tax return, tax losses (and tax loss carry forwards)

can also be used to offset current and future gains when realized, representing

a simple tax planning option available to all investors. But remember, if you plan

to utilize these tax savings, be sure that purchases before or after such tax loss

harvesting don’t eliminate the immediate benefits through unintended wash sales.

And one final note…tax loss harvesting should be approached with consideration

to the investment characteristics of your entire portfolio. Should you sell securities

to harvest losses—or for another reason—and plan to buy other securities with

the proceeds, consider replacement purchases that support the appropriate overall

asset allocation and risk profile of your portfolio.

The tax information contained herein is general in nature, is provided for

informational purposes only, and should not be considered legal or tax advice.

Fidelity does not provide legal or tax advice. Fidelity cannot guarantee that such

information is accurate, complete or timely. Laws of a particular state or laws

which may be applicable to a particular situation may have an impact on the

applicability, accuracy, or completeness of such information. Federal and state laws

and regulations are complex and are subject to change. Changes in such laws and

regulations may have a material impact on pre- and/or after-tax investment results.

Fidelity makes no warranties with regard to such information or results obtained

from its use. Fidelity disclaims any liability arising out of your use of, or any tax

position taken in reliance on, such information. Always consult an attorney or tax

professional regarding your specific legal or tax situation.

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Beyond the $3,000 maximum

allowed deduction on each year’s

tax return, tax losses (and tax loss

carry forwards) can also be used

to offset current and future gains

when realized

+/–


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1 if an investor believes the position will appreciate significantly within the next 30 days, it might not make sense to harvest the loss if this tax savings is less than the expected after-tax gain in the short-term.

2 the tax strategies discussed in this report are applicable regardless of the situations in other accounts.

3 in this example, the investor had only one item of capital gain for the year. in years where an investor realizes more than one item of capital gain, the way in which different items of gain and loss may (or may not) be netted against each other also would need to be considered.

4 the tax savings is based on a 25% marginal rate for ordinary income at the $100,000 level. For investors in the highest marginal income tax bracket of 35%, the tax savings would be $1,050.

5 the potential tax savings indicated uses the appropriate netting procedures for realized short- and long-term gains and losses and is not just based on utilizing the $3,000 maximum allowed deduction. in other words, unrealized losses that could have been harvested were applied against actual realized gains and losses in order to calculate the potential tax savings.

6 in general, a wash sale occurs when securities are sold at a loss and then substantially identical securities are purchased within 30 days before or after the sale. in this event, losses on the sale are not allowed as a deduction for tax purposes. if the intent is to buy replacement securities either before or after the sale, care must be taken in order to avoid the wash sale period. the wash sale period for any sale consists of 61 calendar days: the day of the sale, the 30 days before the sale and the 30 days after the sale. there are other consequences of a wash sale in terms of its effect on the basis and holding period of the replacement security. Be sure to consult your tax adviser for specific details.

67%

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BOstOn, Ma 02110

the Fidelity research institute (“Fri”) is affiliated with Fidelity Brokerage services, however Fri is not a bank, broker-dealer, investment advisor, deposit broker, financial planner, credit counselor, or other advisor to you.

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Tax Harvesting by Fidelity