If you ever questioned whether you should sell stocks for a loss, tax loss harvesting may be the answer you were looking for.
After reading this post, you will understand what tax loss harvesting is, the benefits of tax loss harvesting, and the rules you need to keep in mind when performing tax loss harvesting so you do it properly.
Ok so let’s jump right in by answering what is tax loss harvesting.
What is Tax Loss Harvesting?
Tax loss harvesting is the practice of selling stocks at a loss and then buying a like-kind investment to replace it. Now you may be scratching your head wondering why would anyone want to sell at a loss just turn around and buy something similar.
And the reason is quite simple.
Through tax loss harvesting, aka selling at a loss, you can lower or completely offset future capital gains from investments that you sell and make a profit on.
Basically, you sell to save (on taxes).
Now, a couple of questions may come to mind when you hear this. Like how much can you save? Or when does it make sense to sell?
Let’s answer those questions and more, starting with how much you can save.
How Much Can You Save With Tax Loss Harvesting?
When you sell an investment, you will pay short-term or long-term capital gains tax depending on how long you’ve held the investment.
If you hold an investment for a year or less and sell, you will pay short-term capital gains tax. The short-term capital gains tax rate equals your ordinary income tax rate — your tax bracket.
If you hold an investment for more than a year and sell you will pay long-term capital gains tax. The long-term capital gains tax rate is 0%, 15% or 20% depending on your taxable income and filing status.
Here’s a look at both short-term and long-term capital gains tax rates depending on your tax bracket:
But how much can you save by harvesting your losses?
Ok, here’s the answer.
When it comes to capital gains from the sell of an investment, you can offset 100% of the loss to the gain.
Here’s an example: say you sold Stock B for $50,000 in gains and sold stock C for $30,000 in losses. Your net capital gain would only be $20,000.
Sounds good right? Even better is that even if you don’t have any gains, you can use tax loss harvesting to offset your ordinary income.
You can use up to $3,000 in losses to offset up to $3,000 of ordinary income for the year – this changes to $1,500 if you’re married, filing separately.
If you have more than $3,000 or $1,500 if you’re married, filing separately, in losses, you can carry it over to later years until it is completely used up.
Ok, now that we know what tax harvesting is and how it can help us save on taxes, let’s discuss two rules to remember so you perform tax harvesting properly.
Rules in Tax Loss Harvesting
1. Wash sale rule
This rule disallows your loss if you sell a security and purchase a “substantially identical” security in 30 days or less.
For even more clarity, the IRS states the following:
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you:
– buy substantially identical stock or securities,
– acquire substantially identical stock or securities in a fully taxable trade,
– acquire a contract or option to buy substantially identical stock or securities, or
– acquire substantially identical stock for your individual retirement arrangement (IRA) or Roth IRA
And if you thought that maybe you could have your spouse buy the identical security within 30-days and you take the loss. Think again.
If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale.
If you do perform a wash sale, you can add the disallowed loss to the cost of the new stock or securities which would be the cost basis for your new purchase.
BUT the easiest way to avoid a wash sale, is to not purchase a security or stock until 31 days after performing tax loss harvesting.
2. Tax loss harvesting only applies to investments held in taxable accounts.
401(k)s, 403(b)s, IRAs and 529s cannot take advantage of tax loss harvesting because they are not generally taxable.
Now, should you go selling and taking losses just to take advantage of tax loss harvesting? The true answer is it depends on your specific circumstance and the reason the security is losing value.
In any case, remember that time in the market typically beats timing the market.
There you have it, a complete breakdown of tax loss harvesting. If you need help with your taxes, wealth management or want to talk to a reliable financial advisor, we would love to help you out! Simply fill out this form or call us today.