Your portfolio may be in the red, but your tax planning just might be in the green – if you know how to work those losses.
Anxiety around the spread of coronavirus, along with recession fears, have sent major stock indexes into a tailspin.
While selling out of the market altogether could hurt your long-term plans, getting rid of a few losers could ultimately improve your tax picture.
It’s a strategy known as “tax-loss harvesting,” in which you incur losses in a taxable account and prune holdings that have fallen in value. Use these losses to offset capital gains from other appreciated assets that you may have sold.
Tax-loss harvesting is important all the time and in a time like this, there will be more opportunities to engage in tax-loss harvesting, but there are securities that are going up and down all the time – and opportunities from tax-loss harvesting all year round.
Embrace the downside
In order to benefit from tax-loss harvesting, you’ll need to realize those losses by selling off those positions.
Book the loss by the end of the year, and you can use it to offset any capital gains you realized elsewhere within the portfolio.
If your losses exceed your gains, you can apply up to $3,000 a year to offset ordinary income.
When you harvest losses, redeploy the cash and buy other investments to maintain your portfolio’s allocation.
Some of our clients see it as an opportunity and want to rebalance their portfolios or add money to their accounts to buy stocks.
Just be careful of the wash-sale rule.
Avoiding wash sales
If you sell your investment (it doesn’t matter which kind) at a loss and snap up an asset that’s substantially identical to it within 30 days before or after the sale, the IRS won’t let you claim the loss on your return.
This is a wash sale.
Wash-sale rules apply to all the accounts in your household. For instance, if you sell a holding in your taxable account but buy it back in your 401(k), you’ve violated the rule.
The same is true if you sell your loser in your brokerage account, and your spouse snaps it up elsewhere.
The wash-sale rule applies per taxpayer, and a married couple is a taxpayer.
Dollar-cost averaging programs, in which you automatically invest into the market periodically, can also trip up investors.
For instance, you sell a losing mutual fund, but you forget to look back into the last 30 days when you were automatically snapping up shares. In that case, you’ve triggered a wash sale by buying shares within 30 days of the tax loss sale.
Know when to do it
For one thing, you and your advisor will need to be aware of your tax situation and applicable rates. Those are key in figuring out whether selling your losers will work for you.
If you sell a security you’ve held for less than a year, you’re recording either a short term-gain or a short-term loss. Short-term gains are taxed at the same rate as ordinary income, up to a top rate of 37%.
If you’ve held a security for more than a year and you sell it, you book either a long-term capital gain or a loss. Long-term capital gains are subject to a maximum tax of 20% but for most of us, it’s 15%
Short-term losses will first offset short term gains, once those are covered, they can be applied to long-term gains. This is the same for long-term losses which cover long-term gains first than can be applied to short-term gains.
Harvesting losses is something we at Kendall Capital do on a regular basis and with the market in turmoil we are and have been harvesting losses proactively and having this conversation with our clients.