After a year of market volatility, keeping track of your capital losses can be your gain
Last year, we saw the stock market experience significant drops in a single day and the cryptocurrency market unravel.
In a volatile market such as this, investors may have lost money on an investment in the stock market. If this is the case, not all is lost. When used strategically, tax-loss harvesting can provide a tax benefit for investments in a loss position.
Tax-loss harvesting entails purposefully selling an investment that has lost value from the original investment amount and utilizing the loss to reduce an individual’s tax burden, says CPA Matt Peterson.
“Tax-loss harvesting can allow investors to take advantage of their losses and use it to reduce their taxable gains,” said Matt.
The IRS stipulates that $3,000 in capital losses can be applied against the taxpayer’s ordinary income. To simplify this, if your taxable income last year was $100,000, and you offset that by the maximum $3,000 capital loss allowance, then your taxable income is $97,000.
“That’s great, but $3,000 is really not that much money, especially as the $3,000 figure is not tied to inflation,” Matt Peterson said. “Investors more commonly use loss harvesting to adjust their positions and balance out gains they have had in other positions while minimizing the tax impact.”
For example, say an investor gets a great return with one investment but sees a loss with another. The investor can use the loss to offset the original amount gained, and thus the investor would owe fewer taxes on their gains.
At the end of each calendar year, investors receive a 1099 tax form showing their investment accounts’ net losses and gains. Even though this form is produced annually, losses on investments can and should be harvested throughout the year.
“Investors may have outsized positions in big companies that have had significant gains over the past few years, but now if they want to reallocate their investments, they might be realizing a significant gain which creates a large tax burden,” said Matt. “By harvesting other losses in other positions, they can reallocate to a more diversified asset allocation.”
Seizing an opportunity to harvest capital losses on investments has additional rules investors must abide by, the most significant being wash-sale rules.
Under the wash-sell rules, most taxpayers who sell stocks and then purchase other similar stock within the holding period, 30 days from the sale date, may not claim a loss on the stock sale. So not only are losses unable to be harvested, but the loss amount is also added into the calculation of the new stocks’ basis.
“So if you buy something for $100, and you sell it for $90, that $90 can be reinvested elsewhere, but it has to be substantially different from what you just sold to avoid disallowing that loss,” Matt said.
Cryptocurrency is currently not included in wash-sale rules. That can make investing in this attractive to some investors, given the high fluctuations in cryptocurrency investments.
Other factors at play in this strategy include cost basis methods to determine if the gain or loss is considered short-term or long-term. There are tax implications for each, and this is where your CPA and IAR come in.
“Tax-loss harvesting is great in theory. Not every investment you make is a winner, and that happens,” said Matt. “But you have to make sure you know the tax laws associated with capital gains and your holding periods to make sure you’re tax-loss harvesting correctly.”
Our CPAs are also investment advisor representatives, meaning they can look at the entire picture of your financial life and make a comprehensive strategic plan just for you.
