Losing money on an investment is never fun, but the strategy we are highlighting this month can make losing money a bit less painful. Inside non-qualified accounts (Joint Accounts, Individual Accounts, Trusts, etc.), you realize capital losses if you sell investments for less than you paid for them. This capital loss can reduce your realized capital gains and can even reduce your ordinary income. Reducing gains and/or income obviously reduces your tax liability, but it doesn’t have to come at the expense of future gains. When you sell an investment at a loss, tax law forbids you from buying that asset back immediately. However, you can buy the asset back after 30 days (on the 31st day). You can also buy another asset as long as it’s not “substantially identical” in hopes of similar or better returns.
Here is an example of Tax-Loss Harvesting:
In September, you sell Apple stock for a loss of $5,000. Earlier in the year, you sold Pepsi stock that resulted in a gain of $2,000. These transactions offset one another for a net loss of $3,000.Because you believe Apple’s decline in value was due to the overall economy and not the company in particular, you choose to redeploy the sale proceeds into Microsoft stock which you believe will increase in value similar to Apple. By December, Microsoft has increased in value by $5,000. The end results are:
• Reduced capital gains by $2,000
• Reduced ordinary income by $3,000
• Total account performance was positive for the year
As we have mentioned before, it’s important to consider taxes when investing but it shouldn’t be your main concern. The primary goal of investing is to grow your assets. However, there are times when it can be beneficial to sell your investments at a loss.
The specifics of this strategy require careful consideration. Please let us know if you would like to learn more about utilizing the losses in your non-qualified investment accounts to reduce your taxes.
By: Adam Grant