This article covers:

• What is Tax-Loss Selling?

• How do Shares Perform Amid Tax-Loss Selling?

• Considerations of Tax-Loss Selling

• Final Thoughts

Each June, investors begin to look ahead to the end of the financial year, as well as tax time.

As the window shuts on one financial year, investors typically begin reorganising their 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.

What is Tax-Loss Selling?

Tax-loss selling is a strategy adopted by a wide range of investors to manage tax obligations. The purpose behind tax-loss selling is to reduce one’s net capital gains for the financial year, which ends June 30. In more simple terms, offsetting your losses against your profits.

It involves selling shares where you are sitting on a loss, which may then reduce your total capital gains (i.e. profit) realised throughout the financial year. The intent is to minimise tax that you might owe from investing in shares.

Some investors have difficulty converting a loss on paper into an actual loss. However, it is crucial to remove emotion from any investment decision in order to see the forest for the trees. The price you previously paid for a stock is not as important as the benefit or opportunity moving forward.

Learn how to manage such cognitive biases as an investor. 

How do Shares Perform Amid Tax-Loss Selling?

For certain stocks, the month of June sometimes sees things go from bad to worse. This is most frequently the case for underperforming stocks. Investors may look to exit shares that have underperformed the broader market throughout the financial year. This capital could be used to invest in shares that might have a better outlook.

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 amid reduced trading volumes, or a lack of ‘liquidity’.

When there is reduced liquidity, sellers might reduce their asking price to match the best offer available on the market. The alternative is that a seller does not reduce their asking price, and they might not be able to sell their shares in that financial year. Even blue-chip stocks can suffer from tax-loss selling when they underperform relative to their peers.

Read here for a recap on bid and offer prices.

As shown below, since 2002, the ASX 200 has seen varying levels of returns before the end of the financial year. Sometimes the market is full of sellers, and on other occasions buyers have been in control.

Considerations of Tax-Loss Selling

While the merits of tax-loss selling will depend on each individual’s personal circumstances, there are some broader considerations to ponder when investing in shares.

First, tax-loss selling is based entirely on your specific financial position. It is meaningless to look for a designated list of stocks to sell. The only stocks that might be relevant for a tax-loss sale are the ones in your portfolio.

Your choices will depend on:

• The stocks you own.

• The outlook of the stocks you hold.

• The prices you paid for the stocks you own.

• The weight of the stocks in your portfolio.

• Your current paper losses.

• Any profits that you may have already converted this financial year – to offset against.

Consider why you bought a stock in the first place, and avoid a panicked decision made solely for tax reasons.

In addition, your expected income and marginal tax rate for the financial year are also important to consider. Both of these factors dictate the size of any potential tax savings. In fact, it is possible to carry forward capital losses to future 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. Other investors might be inclined to continue investing in alternative stocks. Tax-loss selling may even encourage investors or traders to buy a ‘beaten-down’ stock in hope of a recovery.

Finally, it is also important to be aware of a very important ATO provision. The ATO will disallow any capital losses where an investor has engaged in what is known as a “wash sale”. A wash sale 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 the sole purpose of a trade was to minimise tax, it has the power to exclude that loss from your tax return.

Final Thoughts

Tax-loss selling isn’t limited to June. At any time throughout the year, investors might consider crystallising a loss as part of this strategy.

However, due to wash sale provisions enforced by the ATO, the decision to sell a stock as part of a tax-loss selling strategy should be viewed as a definitive action.

Nonetheless, the above considerations of tax-loss selling are a starting point for investors to weigh up. Always consult an accountant to understand how your personal financial circumstances might apply.