2022 has been a rough year for investors.
Year-to-Date the S&P 500 is down almost 20%, the Nasdaq 100 is down 34%; large caps such as Google (GOOG), Amazon (AMZN) and Tesla (TSLA) lost 41%, 54% and 65% respectively.
That's not a pretty picture. We can all agree on that. But there's a silver lining here.
The IRS permits individuals with red portfolio pages to reduce gains and income using their investment losses.
In fact, investors can take advantage of what is called tax-loss harvesting and lower their 2022 tax bill until the end of the year.
Tax-loss harvesting explained
Tax-loss harvesting requires knowledge of capital gains taxation. So, how's capital gain taxed?
A capital gain is realized when investors sell a taxable investment for more than they paid for. Profits from investments held for a year or less are taxed at the regular income rate of the individual. Long-term capital gains rates range from 0% to 23.8%, depending on the individual's income.
Tax-harvesting can reduce the investors' costs. They can use a loss from selling an investment to offset taxable gains.
First, offsets must match. Short-term losses should offset short-term gains, long-term losses long-term gains. Then, excess losses can offset opposite gains.
Afterward, investors can use up to $3,000 of their net loss to offset ordinary taxable income. They can roll over any additional negative money into the next tax year.
How tax-loss harvesting works
Let's say that you have $20,000 invested.
If the current value of your investment is $15,000, you have an unrealized $5,000 loss. If these positions remain open and the value of your investment goes back to $20,000, you have no loss (and no gain).
On the other hand, if the current value of your investment is $15,000, and you close your position(s) you have a realized (an actual) $5,000 loss.
If, after the sell, you repurchase at $15,000, you've done what's called harvested a $5,000 loss while getting the same return.
That's against the IRS rules.
The "wash-sale" rule compels you to wait 30 days before reinvesting or buying a "substantially identical" investment. Basically that means that you must wait a month after selling a specific stock.
This rule can by-passed if you buy, for example, an exchange traded fund (ETF).
For example, if you sell 100 shares of SPY (S&P 500 ETF) and purchase 100 shares of a different index ETF, let say the QQQ (Nasdaq 100 ETF) your transaction might not fall under the wash-sale rule.
If investors no longer trust a stock or fund over the long term, they may choose to sell it for a more diversified investment, meaning, they might choose to sell a speculative investment in favor of a low-cost index fund.
This action could save them money on taxes, while also potentially improve their financial future.
However, investing and tax experts note that tax-loss harvesting isn't for everyone. Always consult your financial advisor and/or tax pro before making substantial portfolio adjustments.
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