A volatile year in the financial markets can create opportunities for reducing your taxable income.
Many investors use the closing months of the year to review their portfolios and assess their winning and losing investments. It’s also a good time to do tax planning for the upcoming filing season; decisions you make before year-end can help you lower the taxes you own on your ordinary and investment income.
Tax-loss harvesting is one strategy many investors use to offset taxable investment income and capital gains with capital losses. After a volatile year in the markets, you may see a stark divide between winners and losers in your portfolio. There is opportunity, however, to consider selling certain investments that realize losses you can use to lower your overall tax bill.
Use losses to lower your tax liability. Tax laws permit you to take a credit for any investment losses you incur during the calendar year to lower realized capital gains and possibly your taxable income. For example, let’s say earlier this year you sold a stock position you’ve held for several years and realized a profit of $1,000. This profit will be taxed as a capital gain at a rate of as much as 20%, depending on your tax bracket. However, let’s say you sold another long-term stock position this past year for a loss of $600. You can use this capital loss to reduce your total capital gains for the year to $400. The most you’d pay in taxes would be $80. ($400 capital gain x 20% maximum cap-gain tax rate.)
You can also use tax-loss harvesting to reduce your ordinary taxable income, if you realize losses in excess of your total capital gains for the year. You can apply capital losses up to $3,000 in a calendar year—a small amount, but potentially significant if the credit lowers your total annual taxable income and keeps you from moving into a higher tax bracket.
Carry over excess losses for the future. If your total losses for the year exceed your total capital gains, you can also apply these losses against future capital gains by carrying them over to another tax year. The IRS caps this capital-loss carryover at $3,000 per year, but you can extend the losses over consecutive years until the entire amount of the capital loss is applied.
Know the “wash sale” rule. If you plan to sell a security for a loss, the IRS forbids the purchase of the same security or a “substantially similar” security for 30 days before and after the sale. This type of transaction is known as a “wash sale”. It’s an important rule to remember if, for example, you want to sell an indexed ETF and purchase another ETF linked to the same index. Violating the wash-sale rule could disallow any offset losses, not only for the current tax year but potentially future tax years as well.
Dr. Jason Van Duyn
AQuest Wealth Strategies
Dr. Jason Van Duyn CFP®, ChFC, CLU, MBA is a Registered Representative with and Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor. Member FINRA & SIPC. The LPL Financial registered representative associated with this site may only discuss and/or transact securities business with residents of the following states: IN, IL, TX, MI, NC, AZ, VA, FL, OH and CO.