For many investors, 2022 cannot end fast enough.
Stocks would need a huge rally to finish the year in the black. But with only six weeks left in the year, and the Fed committed to fighting inflation with rate hikes, the chances of that are low.
But taking a loss in a taxable account can be very beneficial—as long as you understand the rules…
No. 1: Harvest your losses
Tax loss harvesting is the practice of selling a security at a loss in order to offset taxes on both gains and ordinary income. (Bear in mind, it can only be applied to your taxable accounts—not to your 401(k) or IRAs.)
Investors can harvest a loss to offset capital gains in the same year…
If there’s any loss left, you can then use it against $3,000 of ordinary income… Any leftover after that can be carried forward to offset capital gains (or $3,000 of ordinary income) in a future year.
The harvesting process is simple…
Start by reviewing the capital gains and losses you’ve taken this year.
Note that gains and losses should be first matched by their category (short-term gains—those made on investments held for one year or less—are netted against short-term losses… and long-term gains are netted against long-term losses).
Then, you’ll want to review your portfolio for candidates to harvest.
For example, some stocks in your portfolio might be too speculative for this higher-rate market… Those could be candidates for taking a loss.
Or maybe you’ve held onto a few stocks with large gains for years—and the only reason you haven’t locked in the profits is that your cost basis is so low (and taxes would be too high)… Those are candidates for taking a gain (and netting against a loss).
You should never sell a position solely for the sake of booking a loss—or for the sake of taking a gain. Remember, your long-term investment gains are much more important than any short-term tax savings… so your tax strategy should be secondary to your long-term investment strategy.
Hold onto your winners if you still like them… and research your sell candidates to make sure you’re willing to part with them. But if you believe a few underperforming stocks are unlikely to deliver on your investment strategy, it may be worth cutting your losses—and using these positions for tax loss harvesting.
Plus, you can always repurchase these shares down the line… or replace the position with a similar one.
But if that’s your plan, always remember the wash sales rule…
No. 2: Watch out for wash sales
The wash sales rule says that if you plan to deduct a loss, you can’t turn around and buy the same or a “substantially identical” stock or security for 30 days prior to the date of sale, and 30 days after (61 days in total).
If you do, the deduction may be disallowed.
In other words, if you take a loss on Apple… but turn around and buy it back before 30 days have passed, you won’t be able to deduct the loss from your taxes. You also can’t buy an Apple call option to replace your Apple shares if you plan to take a writeoff—that could be considered a “substantially identical” position.
Similarly, you can’t replace one S&P 500 index fund with another. Since they both track the S&P, they’re considered “substantially identical.”
The wash sales rule applies across both taxable and tax-deferred accounts. So you can’t sell one stock in your brokerage account and then buy a “substantially identical” one in your IRA… Also, one spouse can’t sell the stock only for the other spouse to go buy it instead (within the 61-day window).
No. 3: Watch your calendar
Another point to remember: The last trading day of December 2022 is your final chance to sell a losing position in order to harvest the loss come tax time.
And always remember to consult your tax advisor before making any changes. Everyone’s situation is different, and you’ll be better off if you consult your accounting professional before making important tax-related decisions.
But by following these simple steps, you could help minimize the pain of your capital losses… and your 2022 tax bill.
P.S. Not everyone is taking massive losses this year…
Members of my Moneyflow Trader service just locked in their 17th and 18th winners of 2022… many for 100% gains or more.