It's always important to reduce taxes, and one way that may help is a process called tax-loss harvesting. This involves selling investments that have lost value, to offset any capital gains you may have realized - hey, maybe you sold Exxon this year. This is something that should generally be done before the year end. There are several advantages of loss harvesting in an investment portfolio, but it's also important to understand the rules. Let's take a quick look:
How and Why
In non-retirement accounts, if you sell an investment for more than you paid for it, that's considered a realized capital gain and subject to taxes. If you sell an investment for less than you paid, that's considered a realized capital loss. The gains and losses can be short-term or long-term depending on how long you held the position.
The IRS allows you to net out realized capital gains against realized capital losses to reduce your tax. There are ordering rules to follow when netting out short-term gains/losses and long-term gains/losses - consult with your CPA or a financial planner for more on this.
If you have more losses than gains, you can use up to $3,000 of leftover losses against your taxable income. At this point If you still have leftover losses, you can carry the amount forward indefinitely until you use them up by repeating this process each year. Even if you have years in which you have no realized capital gains, you can still use up to $3,000 in losses against ordinary income.
5-Star Tip: Try to generate $3,000 in losses each year against ordinary income.
In a well-diversified portfolio with multiple positions, even in good market years, it's not uncommon to find one or two duds in there during the year that you can sell at a loss.
Note: selling stocks at a loss may not make sense if you are in a 0% cap gains bracket or if you have no cap gains to use against your losses. Consult with a financial planner.
Heed the Wash Sale Rule
The wash-sale rule prevents you from taking easy advantage of losses on investments. Essentially, it keeps you from selling an investment for a loss and then immediately buying it back or replacing it with a "substantially identical" investment. Substantially identical is an IRS term, and not super easy to get around.
The wash-sale period is 30 days before or after the sale. If you trigger the wash sale, the IRS will not allow you to write off the loss. This can surprise a taxpayer, for example selling a stock at a loss in your joint account and buying the same stock back in your IRA can wash you. One way to avoid the wash-sale rule is to wait 31 days before buying it back. Also, you could replace it with a not "substantially identical" investment.
With a little planning, you can avoid the wash-sale rule and keep your taxes lower. While tax savings is important, you should make sure that your portfolio is well-designed and that you are on track to meet your financial goals. If you would like a financial check-up, please feel free to contact me.
John Piershale, CFP®, AEP®
John Piershale Wealth Management, LLC is an Investment Adviser registered with the State of IL and in other jurisdictions where exempt from registration. All views, expressions, and opinions included in this communication are subject to change. This communication is not intended as an offer or solicitation to buy, hold or sell any financial instrument or investment
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The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but are intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax or financial advice. Please consult a legal, tax or financial professional for information specific to your individual situation.