By Andrew Keshner
There’s a tax-planning strategy that shouldn’t be reserved for wealthy households, experts say
Here’s a consolation for anyone who’s been maimed in the stock market this year: the hits your portfolio has taken may offer some benefits come tax season.
It’s a strategy called “tax loss harvesting,” and as year-end tax planning approaches, financial experts say this heavy-sounding strategy shouldn’t just be reserved for the wealthy.
“Anyone who is a taxpayer and has investment funds has the opportunity to take advantage of them, especially in a volatile market,” said Jonah Gruda, tax partner in the family wealth services group at Marcum, a firm national accountancy and consultancy.
The phrase “reaping tax losses” can sound daunting to some people, said Frank Newman, portfolio manager at Ally Invest, the brokerage arm of Ally Financial (ALLY).
But people shouldn’t be intimidated by the tax tactic of collecting capital losses to offset gains and reduce taxable income, he said. “It’s a great strategy for everyone, regardless of account size,” Newman said.
Selling at a loss seems quite easy in this market. Even with a strong October, the Dow Jones Industrial Average is down about 12% year-to-date. The S&P 500 is down more than 19% and the Nasdaq Composite is down more than 29%.
To exploit the benefits of tax loss reaping, investors must choose investments for losses and they must choose when to take those losses (and also not get back into the same position too soon due to tax rules). It sounds a lot like an attempt to time the market – a practice many investment experts say people should avoid when working towards their long-term goals.
There is a tax aspect and an investment aspect to the strategy, Gruda said. “A lot of the time, those two goals don’t align seamlessly.”
It’s been said that people shouldn’t let the “tax tail” wag the dog when it comes to investments (and the same goes for big purchases based on tax incentives, like vehicles electricity and energy-efficient renovations).
But the market might tempt many to at least consider the idea of profiting from capital losses. Here’s a look at some of the finer points of the subject:
Learn the basics
Start with the capital property tax rules. This includes stocks, bonds, a share of an exchange-traded fund, a piece of cryptocurrency, and more.
Selling for profit and capital gains apply to the difference between the original cost basis to the owner and the sale. For many people, the tax rate will be 15% on long-term capital gains, meaning the owner owned it for at least a year before selling it.
The 15% rate applies this year to people earning between $41,676 and $459,750, and for married couples filing jointly it is $83,351 to $517,200.
Short-term capital gains are bought and sold within the year, so the IRS treats the proceeds as ordinary income that is lumped in with other income. It is then taxed according to the tax bracket where the person lands.
Selling at a loss and the capital loss applies to the difference between the acquisition price and the selling price. Losses offset gains, then excess losses up to $3,000 can be deducted from income. The remaining losses are carried forward to future years.
According to Fidelity Investments, short-term losses are applied against short-term gains first, and long-term losses are offset against long-term gains first. Once one type of gain is completely reversed, the amount of the remaining loss can be applied to the other type of gain, Fidelity said.
For this reason, it’s important to start by seeing where short-term losses can outweigh short-term gains, which will be subject to a higher tax rate.
There is another starting point, Gruda said. How much would the potential tax benefit this year outweigh the investment benefit of holding the investment and foregoing the strategy?
There is no one-size-fits-all answer, he said. In some cases, this may be too low a gain. In others it can be a big move. If a taxpayer is betting they will realize large capital gains in 2023, or later, loss carryforwards can be a useful tool to deploy.
Yet Uncle Sam ends up getting a cut in profits made through asset appreciation. Harvesting tax losses “mitigates and defers the tax bill. It does not eliminate tax liability down the road,” Gruda said.
Don’t get soaked in the wash sale
Even if someone is selling at a loss from their brokerage account or IRA, they may not want to exit a portfolio position permanently. They may want to get back into an investment now at a lower cost with room for growth.
Just wait a moment, per the IRS “wash-sale” rule.
The IRS will not count a capital loss if, within 30 days before the sale or within 30 days after, the taxpayer also purchases or acquires a “substantially identical” investment. The rule applies to investments like stocks, bonds, mutual funds, exchange-traded funds and options – but not cryptocurrency
The basic trick is just to follow the days, Gruda said. He’s seen his share of people who lost tax benefits “because they didn’t watch the clock.”
Another skill is to consider what is considered “essentially the same” for the quick trader who sees a buying opportunity 30 days before or after the day of the sell.
An investor could sell a stock and buy an exchange-traded fund or mutual fund containing the stock and not break the rule, Gruda said. Going the other way, from a mutual fund or ETF containing a stock to a direct purchase of stocks, will also not trigger the rule, he noted.
Suppose an investor has multiple investment accounts – maybe one is a long-term account and the other is more for short-term trading. The rule applies to all accounts, Newman noted. So if one sells and the other buys within 30 days before or after, the wash sale rule will eliminate the capital loss, Newman said.
Buying and selling shares of two different funds tracking the same index during the 30-day period could also cause the wash sale rule to kick in, Newman said. However, a move like selling part of an ETF tracking the S&P 500 and then soon buying an ETF tracking the Russell 1000 index would be OK according to a tutorial by Charles Schwab (SCHW). “It would preserve your tax break and keep you in the market with roughly the same asset allocation,” one explainer said.
But while someone is considering a buyout and letting the wash sale window close in one place, they may have a chance to start the tax strategy process in another part of their portfolio. “There really are tax loss reaping opportunities in a number of different asset classes this year,” Newman said.
(END) Dow Jones Newswire
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