The end of the year is nearing. You might be able to take your poor stock picks and recover some of your money by realizing a few tax breaks. Harvesting your losses on your income taxes is an effective way to put more money in your pocket come April. Few investors understand just how powerful it can be.
Even if you want to keep a stock that has performed poorly, it can still be well worth the risk to sell it and repurchase it in a month.
Tax loss harvesting has three primary tax benefits:
- It can serve to defer capital gains taxes far into the future. By offsetting your gains, you’re in essence receiving a tax-free loan that you can use to invest in other securities. Until you realize any gains from the next round of investments, you’re deferring your capital gains taxes.
- You can deduct up to $3,000 from your income. For many investors, the tax on personal income is higher than the tax on capital gains. If your losses are greater than your gains, you can apply the remaining loss to your personal income.
- You can roll your losses over into the future. Suppose your losses were $5,000 greater than your gains. You could write off $3,000 from your income this year and $2,000 the following year.
Consider how powerful this can be. The ability to deduct losses from your income is a huge advantage.
Harvest your losses wisely:
- Be aware of the wash-sale rule. The IRS doesn’t like it when you sell a security for the purpose of receiving a tax break. Hence, there is a law. You cannot repurchase a stock within 30 days if you choose to write off your loss. You also have to wait 31 days after purchasing a security to sell if you want to write off the loss.
- Be aware that the rule applies across multiple accounts. So, you can’t sell a stock in your brokerage account for a loss and purchase the same stock in your Roth IRA in less than 30 days.
- Keep your transaction costs in mind. In today’s world, transaction costs are normally very small. But consider the costs when deciding if harvesting your losses is worth it. If you’re selling a small account of stock, or the loss is small, it might not make financial sense.
- Be tactical. Just because your investments are down, doesn’t mean that this exact moment is the best moment to sell. You might be better served by waiting. Consider what the future may hold.
Consider this example of loss-harvesting in action:
Suppose that you had owned a stock for more than 30 days, and the price had fallen by 50% since you purchased it. You like the stock and would like to keep it. You also don’t expect anything exciting to happen in the next 30 days.
You decide to sell the stock for a $7,000 loss. You also have capital gains of $1,000. You can avoid paying taxes on your capital gains, and write $3,000 of your income. You can then rollover $3,000 of loss to the following year. After 31 days, you can repurchase the stock.
You’ve reestablished your position and saved a lot of money in the process.
Have you been taking advantage of your underperforming stocks to the best of your ability? Harvesting your losses intelligently can pay big dividends at tax time. Ensure that you’re taking full advantage of the tax laws.