How Tax Loss Harvesting Can Turn Non-Marital Investments Into Marital Assets
If you’re an investor going through a divorce, you likely have a keen eye on your finances. You may already be familiar with tax loss harvesting, a strategy that can help reduce your tax bill by selling investments at a loss to offset capital gains. While this technique can be a smart financial move, it can also have unintended consequences in divorce—potentially turning what you thought was your separate, non-marital property into a shared marital asset.
What Is Tax Loss Harvesting?*
Tax loss harvesting is a strategy that can be used to lower your tax liability. For example, if you have investments in a taxable brokerage account that have lost value, you can sell them at a loss to offset capital gains from other investments. This reduces your overall taxable income and can lead to significant tax savings.
There are many rules associated with tax loss harvesting. For example, you cannot sell a mutual fund at a loss and then immediately repurchase that same mutual fund. However, one strategy that many investors utilize is to sell one investment at a loss and then purchase a similar, but different, investment. For example, you might sell VTSAX, the Vanguard U.S. total stock market index fund, at a loss and purchase VFIAX, the Vanguard S&P 500 index fund, which is highly correlated with VTSAX. The White Coat Investor website has a really good explainer on tax loss harvesting.
Many investors use this approach as part of a long-term financial strategy, reinvesting the proceeds into different securities to maintain their investment portfolio. However, if you are going through a divorce, you must be careful about how and when you execute tax loss harvesting.
*Please note that we are not accountants, financial advisors, or tax lawyers, this information is not intended to provide advice, and this is for educational purposes only.
How Non-Marital Investments Can Become Marital Property
Florida law generally considers assets acquired before marriage as non-marital property. Inheritances or gifts from someone other than your spouse received during the marriage are also generally categorized as non-marital property. However, certain actions—whether intentional or accidental—such as tax loss harvesting can turn these assets into marital property.
Here’s how:
- Reinvestment in Joint Accounts: If you sell investments from a separately owned account and reinvest them into a joint account with your spouse, those funds may now be considered “co-mingled” and marital property.
- Using Proceeds for Marital Expenses: If you use the money from a tax loss sale to pay off a joint debt, buy a family home, or cover household expenses, you might be converting separate property into marital property.
- Active Trading and Appreciation: Even if you keep investments solely in your name, the way you manage them during the marriage could make a difference. If you hold on to a non-marital investment and it passively grows, it generally would retain its separate nature. But if you are actively trading in your separate account, such as by switching out VTSAX for VFIAX for the tax benefit, then that very act could convert the non-marital investment, or at least any future appreciation, into a shared marital asset.
How a Prenuptial or Postnuptial Agreement Can Protect Your Investments
One of the best ways to prevent tax loss harvesting from unintentionally converting your separate investments into marital assets is by having a prenuptial or postnuptial agreement. These agreements clearly define which assets remain separate and how investment accounts should be managed during the marriage.
A well-drafted prenup or postnup can:
- Specify that all investment accounts remain non-marital, regardless of how they are managed.
- Clarify ownership of appreciation in separate investments, even if active management occurs.
- Set rules on tax strategies like tax loss harvesting, ensuring that any proceeds from sales are not accidentally converted into marital property.
Having a legally sound agreement in place can help avoid disputes down the road and provide peace of mind that your assets will be protected, even in the event of divorce.
Why Investors Need a Collaborative Approach to Divorce
If you’re an investor facing divorce, the last thing you want is a public, drawn-out legal battle. Collaborative Divorce offers a better alternative. Instead of going to court, you and your spouse work together—alongside financial, mental health, and legal professionals—to reach a fair and private resolution.
At Family Diplomacy: A Collaborative Law Firm, we understand the complexities of high-net-worth divorce cases. Adam B. Cordover is a leader in Collaborative Divorce, deftly helping clients navigate through the toughest of choices under challenging circumstances. His experience in handling family law matters involving sophisticated financial topics ensures that you receive expert guidance in a manner that seeks to keep your divorce amicable and efficient. And his advocacy for an interdisciplinary team approach can help you get the perspective of an accountant or financial planner before you make a choice with long-lasting consequences.
We Can Help Protect Your Financial Future
Divorce doesn’t have to mean financial ruin. With the right legal guidance, you can protect your investments and make informed decisions. Let us help you through this process with care, confidentiality, and expertise.
Contact Family Diplomacy: A Collaborative Law Firm today by clicking the button below.
Adam B. Cordover is co-author and co-editor of an American Bar Association book on Collaborative Family Law. He has trained judges, lawyers, mental health professionals, and financial professionals in Collaborative Practice and other forms of private dispute resolution throughout the U.S., Canada, Israel, and France. Family Diplomacy accepts clients throughout the State of Florida through our Virtual Practice, and we have offices in Tampa, St. Petersburg, and Sarasota.
