With farmers for in-laws, I know that the harvest doesn’t end this time of the year just because the cold weather begins. While their fields lay dormant in California during the winter months, they head down to the sunny skies of Arizona to the harvest the crops they planted there a few months ago. And although we’re in the homestretch of 2011, you should be looking to do some harvesting of your own in your portfolio.

If you have a taxable investment account, it may make sense to harvest some capital losses prior to the year’s end. This involves selling securities that are currently in the red to generate capital losses to offset capital gains realized earlier in the year. However, it’s only worth doing if you need those losses to offset gains. If you have capital loss carryforwards from previous years or other deductions that you can use to offset your gains, there is no need to harvest because you would be selling securities that you otherwise might not want to sell at this time. You only want to harvest the losses if they are actually beneficial to your tax situation this year. If you are uncertain about any of this, it is a question worth posing to your tax advisor.

One thing we know from studies in behavioral finance is that human beings don’t like losses; in fact, we hate them and will basically do anything to avoid them, even if it involves making irrational decisions. This phenomenon is known as loss aversion. As wealth managers, we’ve seen loss aversion show up in how investors regard capital loss carryforwards. Without exception, each year we get requests to harvest gains to use up capital loss carryforwards. Because loss carryforwards don’t expire, there’s no real reason for this other than investors’ desire to get these unpleasant losses off their books. So while it often makes sense to harvest losses, you don’t need to harvest gains to use up loss carryforwards; rather, save them to offset gains in future years.

Charitable Donations

Because this is the season of giving, you may be considering making a charitable donation to your favorite organization or cause. If so, you should strongly consider making that donation in shares of an appreciated investment rather than cash. With cash, you only get to write off the value of the donation. With appreciated shares, not only do you get to write off the market value of the security at the time of donation, but you also get rid of your tax liability on those shares. For example, if you give 100 shares of Exxon stock (valued at $80 per share with a cost basis of $10 per share) to your favorite charity, you get to write off the $8,000 gift. But additionally, your unrealized capital gain of $7,000 ($8,000 market value less $1,000 cost basis) disappears. That’s a two-for-one tax savings special. The catch to this is that you must donate shares that have an unrealized gain and that have been held for at least one year and one day. If you donate shares that are at a loss, it actually works against you as you lose your ability to write off that capital loss. If you donate shares held for one year or less, you can only write off your cost basis rather than the current market value. As noted above, if you are uncertain about any of this, you should check with your tax advisor.

Roth IRA Conversions

Beginning in 2010, anyone, regardless of income, can convert their Traditional IRA to a Roth IRA. This involves moving money from a Traditional IRA to a Roth IRA after paying ordinary income taxes on the conversion amount. The benefit is that once that money is in a Roth IRA it is never taxed again.

Since the removal of the income limits last year, we have performed many analyses for clients wondering if a Roth IRA conversion makes sense for them. More often than not the answer was no as our typical client is close to retirement age and in the upper tax brackets. Because of the tax owed on the conversion up front, a conversion is typically more beneficial to younger investors or those in lower tax brackets.

However, given that the tax year is wrapping up, it is worth checking with your tax advisor to see if you have any tax credits, exemptions, deductions, or ordinary (not capital) losses that may go unused this year due to insufficient income. If you do, you can use them up by doing a Roth Conversion and getting the money from your Traditional IRA (where it will be taxed as ordinary income upon distribution) to a Roth IRA (where it will never be taxed again) for free. For example, if you have $50,000 in income for 2011 and $90,000 in ordinary losses and deductions, you can convert $40,000 of a Traditional IRA to a Roth IRA with no tax due. The $40,000 conversion counts as taxable income, but the losses and deductions are enough to completely offset it.

Of all of the tax tips listed in this article, Roth Conversions are far and away the most complex. When we do them for our clients, we do it in conjunction with their tax advisor, so you should definitely consult both your investment advisor and tax advisor before proceeding. But it’s important to get moving soon as the deadline for the conversion is the same as the deadline for harvesting losses and making charitable donations—December 30, 2011 as the last day of the year falls on a Saturday.