If you invest in stocks, precious metals, or cryptocurrency, your assets could become the victim of an increasingly fickle market. Market volatility can be a heart-breaker, even for the savvy investor. That’s why maintaining a robust and diversified portfolio is important.
So how can you use your portfolio’s weakest stocks to strengthen your position? Tax-loss harvesting offers one solution.
What is Tax-Loss Harvesting?
To understand tax-loss harvesting, we’ll need to first look at capital gains. Whether you invest in stocks, precious metals, or cryptocurrency, you’re required to report any annual profit you’ve realized or made on those investments to the IRS. But the tax rate on those gains is not fixed, but instead depends on how long you’ve held the asset. Short-term capital gains (assets purchased and sold within one year) are taxed like any yearly income (at 2022 rates). Long-term capital gains (on assets held for more than a year) are taxed at a lower rate (typically 15% but sometimes as little as 5%). Examples of long-term assets include real estate, undeveloped land, or securities.
So what happens if you’ve had a good year, even a great one, but cashing out your best performing stock before the next bear market would put you in a high-tax-liability position? Tax-loss harvesting is a strategy used by investors to leverage weaker investments to offset large gains. Also called “loss selling,” tax-loss harvesting allows you to sell weak investments at a loss and claim a credit against profits earned from winning investments.
Who Can Take Advantage of Tax-Loss Harvesting?
Investors can sell losing assets at any time during the year, but many find it advantageous to wait until end of year, when they’ve seen how their portfolios have performed. Tax liability is not the only factor to consider as an investor, but strategic loss-selling can offset the tax liability of any big gainers you sold during the year.
Factors to Consider Before Tax-Loss Harvesting
The Wash-Sale Rule
The Wash-Sale Rule states that an investor may not purchase a stock identical or substantially identical to an asset sold at a loss within the last 30 days. So basically, if you just sold a stock at a loss to reduce your capital gains liability, you’d have to wait more than 30 days to reinvest in that stock. The aim of the rule is to stop the short-term sale and repurchase of securities by day traders.
Deductions for net capital losses are capped at $3,000 per tax year. If you’ve taken a loss of greater value, there’s good news, it can be carried over to subsequent tax years to help reduce your tax liability over the longer term.
Sound Investment Strategy
Remember that tax-loss harvesting is just one tool in the savvy investor’s kit. Even a robust portfolio can be disrupted by an excess of short-term transactions, so it’s recommended that you have a long-term investment and tax plan.
Tax-Loss Harvesting Fundamentals
Tax-loss harvesting is a strategy, but for it to be effective, you’ll have to develop an eye for opportunities. Some choose to wait until end-of-year, but tax-loss harvesting can be done anytime. If you monitor your investments carefully you may spot openings for strategic sales. For example, looking to dump a losing stock, look for one that’s down at least 10% in value—that should generate enough of a credit to offset some of the year’s gains.
Also, don’t be afraid to hold a cash position in your portfolio. When the right investment comes along, you’ll want the liquidity to invest. And finally, think about your complete portfolio. How diversified is it? For example, if you have an IRA, you may choose to take a payout there (IRA payouts do not trigger capital gains taxes) and offset the losses in a taxable account.
Examples of Tax-Loss Harvesting
Stock Market Investors
For stock market investors, tax-loss harvesting is fairly straightforward. Say you purchase 100 shares of the Lackluster Mutual Fund at $50 each, for a total investment of $5,000. During the year, the fund underperforms and drops to $40 per share, reducing your investment to $4,000 (a loss of $1,000). You decide to sell, despite the loss. You’ve just practiced tax-loss harvesting. Now look at places where that loss might save you money. Say you decide to sell one of your big gainers for the year, incurring a capital gains lability of $2,000. You can use the $1,000 credit to cut your tax liability for the year in half.
A Note to Crypto Investors
These days the crypto markets are generating lots of investor interest. If you’re invested heavily in crypto, you may have incurred a taxable event and want to use strategic tax-loss harvesting, there are a few things to know. First, crypto investors can take advantage of tax-loss harvesting as stock investors do. And with crypto, the Wash-Sale rule does not apply.
An Experienced Advisor
Investing in today’s markets involves significant risk. That’s why an informed perspective is so important. At Moskowitz LLP, our skilled tax professionals and financial planners can help you build a durable and resilient investment portfolio. We are also prepared to answer even your most complex tax questions. Let us help you make sound choices for your financial future. Contact us today!