Even though this may end up being a subpar year for stocks, you may still realize capital gains, which is a taxable event. What can you do about them? You could recognize investments with a loss and practice “tax-loss harvesting.”
Please note this article is for informational purposes only. It is not a replacement for real-life advice, so make sure to consult your Detalus advisor and tax professional before modifying your investment strategy.
Selling losers to offset winners. Tax-loss harvesting means taking capital losses (you sell securities worth less than what you first paid for them) to help offset the capital gains you may have recognized. Keep in mind that the return and principal value of securities will fluctuate as market conditions change and past performance is no guarantee of future returns.1
While this does not get rid of your losses, it can be an approach to manage your tax liability.
The tax-saving potential. This technique can be used to put your net gains at $0, but that is just the start. Up to $3,000 of capital losses more than capital gains can be deducted annually, and any remaining capital losses above that can be carried forward, potentially, to offset capital gains next year. But remember, tax rules are constantly changing, and there is no guarantee that the treatment of capital gains and losses will remain the same.1
So, by taking losses this year and carrying over the excess losses into the next, you can potentially offset some (or maybe all) of your capital gains next year.
The strategy in action. It is quite simple. Step A is to pick out the losers in your portfolio. Step B is deciding which losers to sell. Step C is giving the green light to those transactions. Your portfolio may reflect your time horizon, risk tolerance, and investing goals. So, before moving ahead with a trade, it is essential to understand the role each investment plays in your portfolio.1
You must watch out for the I.R.S.’s “wash-sale rule,” however. You cannot claim a loss on a security if you buy the same or a “substantially identical” security within 30 days before or after the sale. In other words, you cannot just sell a security to rack up a capital loss and then quickly replace it. Your Detalus advisor can illustrate how a “wash sale” works.1
Watch the fine print on wash sales. The wash-sale rule applies to your entire taxable portfolio, not just one taxable account within it. So, as an example, if you sell individual holdings of stock in a company, you still must wait for the wash-sale window to close before you can purchase shares of that same firm. Also, the wash-sale rule applies to multiple taxable accounts – worth remembering if you and your spouse file your taxes jointly.1
The (minor) drawbacks. It is important to stress that you may not wish to alter a carefully chosen portfolio solely for the tax-loss harvesting, especially if it was built for the long term.
You can only practice tax-loss harvesting in taxable accounts; tax-advantaged accounts are ineligible for this strategy. Costs can add up, so think about those potential costs versus the overall plan before you begin.1
Not just a year-end tactic, but also a year-round strategy. Tax-loss harvesting can also happen throughout the year, not only in December. Talk to your Detalus advisor if you have any questions.