Tax Loss Harvesting to Cut Your Tax Bill
- Author: Jeffrey Simmons
- Posted: 2024-05-04
There are many ways to be proactive with your personal finance strategies even when times are tough. One thing that you can do is look for ways to minimize your tax obligation for the next time that you need to file taxes. While it may not net you any money now, you can always just your withholding to reflect it or wait for a large refund next April. One financial strategy that you can use now to save money on your taxes is tax loss harvesting. Now that some sanity has returned to the markets, this may be the time to engage in this practice.
How Tax Loss Harvesting Helps You
Tax loss harvesting occurs when you sell a stock or security on which you have lost money. Federal tax laws allow you to deduct up to $3,000 annually for capital losses. If you have capital gains, your losses can be used to offset the gains and lower the amount of money that you owe.
Normally, people will sell positions on which they have lost money towards the end of the year. However, there are benefits that you can realize by acting on this now as opposed to waiting for December.
First, stocks have rallied fiercely off of their March lows. Believe it or not, the S&P 500 Index is just over 10% off of its February highs. This is with unemployment over 25% and the second-quarter economic growth likely to show that the entire U.S. economy contracted by one-third. Thus, your stocks that have gotten crushed have likely popped their head up somewhat, giving you an opportunity to sell before market uncertainty takes hold one more time.
Second, when you wait for December, you are not the only person who is in the market looking to sell. Stocks that have gotten crush usually underperform the market in December exactly because others are also selling for the same reasons as you. Thus, it is a good idea to be able to jump ahead of the queue and sell your stock while there is not a steady stream of sellers depressing the price.
Third, if you sell now, you may be able to re-buy the stock at a later point in time and take advantage of a rally in price if the market and your particular company recovers. The IRS has rules that keep you from repurchasing the same or substantially similar stock within 30 days if you want to qualify for the tax benefits. The sooner you sell the stock, the quicker you can get back in if you feel like you still want to own the stock for the long run.
Fourth, you may have been one of the canny and fortunate investors who had the guts to buy the stock market near its March lows. You may even want to take some profits on what you bought. However, by selling you will open yourself up to short-term capital gains taxes. This is the same rate as your income, so you will want to minimize your burden. When you sell for a tax loss, it will offset your gains and keep you from owing money to the federal government whether you are locking in a short or long-term loss.
You Still Need to Be Careful When Tax Loss Harvesting
However, you should be careful and not sell indiscriminately solely for the purpose of tax loss harvesting. Before you sell your stock, you need to have an honest conversation with yourself that every investor must have when they are plotting the future course of their investments. You must assess the realistic prospects of the company and avoid the instinct to "hold onto hope." It may very well be that there are valid reasons for keeping the stock and not selling it. After all, you can only recover for your capital loss in proportion to your marginal tax rate. In other words, you can only recover somewhere between 20-35% of your losses in a tax deduction. If the stock goes up, you would lose 100% of the recovery in price.
Nonetheless, there are situations that merit cutting ties with a particular stock, taking the tax loss and deploying your money elsewhere. It is not an easy decision to make, but it is something that you need to think about well before December this year given the number of stocks that have been beaten down in the market rout.
