December is beginning, which means the year is ending. This also means it’s time to start your year-end tax planning. There are so many subjects that come under the year-end tax planning umbrella that I wanted to break it down into separate pieces. This post will focus on harvesting your losses.
What, you’ve never heard of harvesting your losses? Well, let me explain…
To start, the basic premise is to look for financial capital losses hiding in your investments (stock that you own which is currently valued less than you paid for it) that can offset some of your capital gains. The idea is to reduce your annual tax bill by using capital losses to reduce the amount of taxable capital gains you’ve had during the year.
Let’s break it down
What is a capital gain or loss?
A capital gain or loss comes from selling a financial asset that you own as an investment. When you sell the investment, you have a capital gain if you sell the asset for more than you paid, conversely, you have a capital loss if you sell the asset for less than you paid for it.
What is the tax treatment of capital gains or losses?
This is a quirky section of tax law because gains and losses are not treated equally. The first thing you do is determine if you held the investment long enough to qualify for long-term treatment. Long-term treatment is better because long-term gains are generally taxed at a lower tax rate than short-term gains. To qualify as long-term, you must have owned the asset for more than 1 year.
Once you break out your capital gains and capital losses into long-term and short-term, you net them to get a combined net capital gain or net capital loss for the year. You do this on IRS Schedule D.
A final thought on this section, if you have a net gain, all the gain is taxed. However, if you have a net capital loss, you are only allowed to deduct $3,000 per year of the capital loss. Any loss that you can’t deduct is carried forward to the next tax year.
This is my pet peeve. I don’t agree that losses shouldn’t be treated the same as gains, plus, the $3,000 limit has been the same since I got into the profession back in 1997. It seems that the limit should be indexed to inflation, or at least adjusted from time to time.
How does loss harvesting fit into this?
Well, if you’ve sold a lot of investments and have a net capital gain, you can go through your investments and find some investments that you haven’t sold but have a loss and sell them, this will offset your income from the capital gains.
On the flip side, if you sold some investments that will give you losses greater than $3,000, you might want to consider selling some of your big winners for the year so you don’t have to carry forward as much of the unused capital loss.
Why harvest my losses now?
Over the course of the year, the stock market has had some good rises and good falls, especially over the past couple weeks. If you have capital gains from selling stock earlier in the year, you could sell some of your stock investments that have declined in value to offset the capital gains from your earlier transactions.
Tax advisers will recommend this strategy every year, but, this year might be more important than normal because of the fluctuations in the stock market during 2018. If you sold some investments at a high point, you could have some gains that will be taxed which could be reduced by selling some of your losses before the end of the year.
Is there anything else I need to think about?
I’m glad you asked! Yes, keep in mind the following two pieces of advice:
First, the decision to sell an investment shouldn’t only be for tax purposes. If you have a good investment that has declined in value, don’t just sell it to offset gains if owning this investment still makes sense in your overall portfolio. Typically, you’ll only want to sell investments that you really should be getting out of your portfolio anyway. I always recommend going over this list with your financial adviser before you go selling any investment just because it has a decline in value.
Second, you can’t sell an investment to get a loss and then buy it right back. This is called a wash sale. This rule keeps you from selling a stock at a loss and then immediately re-purchasing it. Under Internal Revenue Cod Section 1091, a wash sale occurs when a taxpayer sells or trades stock or securities at a loss, and within 30 days before or after the sale.
Do you have any final thoughts on this topic?
Yes, this post is intended to give you general information on loss harvesting and isn’t tax advice. Whether you’re familiar with these concepts or they are brand new, I have to encourage you to get assistance with your financial adviser and tax professional before you buy or sell any stock investments, especially if you’re doing so for tax purposes. If you don’t have a tax professional, please feel free to contact me.