When it comes to their portfolios, investors hate to take losses. But sometimes a loss could be just what the CPA ordered. As we wrap up a volatile year in the stock market, many people are starting to think about the tax consequences of all the gains that have been realized in the past year. The good news is that with a few weeks left in the year there are still opportunities to make portfolio changes that could be beneficial from a taxation standpoint.
What Is Tax-Loss Harvesting?
As the name implies, tax-loss harvesting is the selling of securities at a loss to offset a capital gains tax obligation. With this strategy, any realized losses can then be used as a credit against any gains that have been realized in the same calendar year. This strategy can only be used for taxable accounts; IRAs (and other tax-deferred accounts) are not eligible for tax-loss harvesting.
How Tax-Loss Harvesting works?
Short-term losses (investments held for less than one year) can provide the greatest benefit since they can be used to offset short-term gains, which are taxed at your marginal tax rate and often higher than your long-term capital gain rate. Tax code dictates that short- and long-term losses must be first used to offset the same type of gain. Any excess may be than carried over to the other type. For example, if you sell a long-term investment for a loss of $25,000 and only had $15,000 in long-term gains for the year, the remaining $10,000 may then be applied to any short-term gains realized in the same year.
Example: If you were to sell several stocks with a combined long-term gain of $30,000, the full $30,000 would be subject to 15% or 20%* long-term capital gains tax rate, depending on your income. However, if you also sold some stocks for a combined long-term capital loss of $12,000, you would be able to reduce your total realized gains to $18,000. This means your taxable gains for the year would drop from $30,000 to $18,000, which should lead to tax savings.
| Long-Term Capital Gains Rate Filing Status and Income: 2022 | ||
| Long-Term Capital Gains Rate | Single Tax Filers | Married Filing Jointly |
| 0% | $41,675 or less | $83,350 or less |
| 15% | $41,676 – $459,750 | $83,351 – $517,200 |
| 20%* | $459,751 or more | $517,201 |
* Net Investment Income Tax (NIIT), which at 3.8% could cause the capital gains rate to be as high as 23.8% for certain high-income earners
Additional Tax-Loss Harvesting Strategies
Another way to use tax-loss harvesting is to sell investments for a loss even if you don’t have capital gains for the year. Doing this would allow you to utilize the capital loss tax deduction, which states that you can apply a maximum of $3,000 a year in capital losses to offset ordinary income. Any unused loss can then be carried forward to use in future years.
Tax-loss harvesting can also be a great strategy to employee when trying to diversify a highly appreciated / concentrated stock position.
Example:If you have an individual stock position worth $250,000 that has a cost basis of $100,000, you would have a $150,000 capital gain if you sold the entire position. While selling this stock or at the very least a portion of it may make sense from a portfolio management standpoint, the prospect of a large tax bill from the sale may make it unattractive. Now let’s say you have realized $50,000 in long-term capital losses already during the year. You could now sell the individual stock position and reduce your capital gains to only $100,000, which should lead to significant tax savings.
Beware of the Wash-Sale Rule
If you choose to implement a tax-loss harvesting strategy, you should be aware of the wash-sale rule. The wash-sale rule states that you can’t sell a security for a loss and purchase the same security or “substantially identical” security for a period of 30 days before and after the sale date. Violation of this rule will result in the taxpayer not being allowed to claim the loss.
Although tax-loss harvesting is a commonly used tax planning technique, you should speak with your CPA or tax advisor before implementing this strategy. You should also discuss your plans with your Client Advisor to make sure any portfolio changes implemented do not cause violations of the wash-sale rule.
For more information on other year-end tax planning strategies, please see 5 Year-End Tax Planning Strategies
This document is being provided for informational and educational purposes and is not meant to be taken as specific advice. Oakworth Capital Bank does not provide tax or legal advice. All decisions regarding the tax and / or legal implications of these strategies should be discussed with your tax and / or legal advisors before being implemented.