With the recent volatility in the market, there is a chance that you may have some losses that you can use to your advantage. While this sounds like a tax move, the reality is that you may be able to improve your portfolio for next year. However, you have only a few short weeks to do this before year-end.
Generally, we recommend hanging on to an investment providing it still meets your investment objectives. Remember, you’re in the stock market to make money. But, if an investment still meets your investment criteria and you’ve determined your stock holding is down because of normal fluctuations, all is not lost. You may want to consider recognizing your losses to offset your capital gains.
Long-term capital losses must be used to offset long-term capital gains before they can be used to offset short-term capital gains or ordinary income. Individual taxpayers may use up to $3,000 of losses in excess of total capital gains as a deduction against ordinary income. If your capital losses exceed this limit, you can carry forward to later years. Depending on your situation, you may find deferring gains and using capital losses to offset ordinary income may be more beneficial.
When selling for a loss, you need to be careful of the wash sale rule, which prevents you from deducting a loss on the sale of an asset if you buy the same or “substantially identical” asset within the wash sale period. This means if you sell a stock specifically for a tax loss, you cannot buy it back for 31 days (trade date plus 30 days); otherwise, the sale no longer qualifies for a tax loss.
You can keep the proceeds from the sale in cash; however, we generally recommend purchasing a sector or index exchange-traded fund. Placeholder purchases like these allow you to participate in the market action and keep you fully invested. After the wash-sale period, you’re free to sell the placeholder and repurchase the original stock you held. Remember, you didn’t sell it because you didn’t like the stock. This is a tactical rebalancing strategy that helps ensure you’re taking advantage of the loss.
Likewise, if you own mutual funds, there is likely a taxable distribution toward the end of the year. Dividends and capital gains from the underlying assets are paid out to shareholders. As a shareholder, you often have the choice of taking your distribution in cash or reinvesting in more shares of the fund.
In certain circumstances, there can be a benefit by not reinvesting. For example, say you own shares of a mutual fund net asset value of $10 per share that pays a 10% distribution. Toward the end of the year, the distribution is paid, so you get a dollar in cash. At this point, the net asset value of the fund is reduced to $9. If your original cost for the fund shares was $9.50, you now have a loss in your position. In all reality, you received $0.50 more than you initially paid if you didn’t reinvest that dollar; therefore, you could sell your shares of the mutual fund, and wait through the wash-sale period and then buy the mutual fund again. You’ve recognized a loss for tax purposes, but on a total return basis, you made money.
We generally recommend having your dividends paid in cash rather than reinvesting because if you do have a tax liability, you have the cash to pay what you owe. If you don’t have a tax liability by year end, you can also use the cash to buy another position that can help balance your portfolio’s allocation.
As you evaluate your portfolio, taking stock of the winners and losers for the year, remember there may be moves that can help position you for the new year. If you have questions regarding tax loss selling, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
This article is for demonstrative and academic purposes and is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
