In the world of investing, you win some and you lose some. But taxpayers who take advantage of tax loss harvesting strategies can identify opportunities to transform investment losses into tax benefits, as the market moves. Though tax-loss harvesting has a reputation for applying only to high-income earners and wealthy investors, the fact is, any investor who has capital gains from investment activity (and will be on the hook for the taxes that come with them), can benefit from tax-loss harvesting.
Here are some simple steps you can use to review your portfolio, and identify possible tax loss harvesting opportunities that could reduce your 2016 tax bill.
Which investments have lost gained, and lost value since you purchased them?
Tax loss harvesting is identifying which investments—including stocks, bonds or mutual funds—have decreased in value since you purchased them, and strategizing how to use the losses to offset the taxes you’ll owe on investments that increased in value.
When did you purchase the investments?
Short-term capital gains (or losses) apply to investments held for less than one year; long-term capital gains apply to those held for one year or more. Short-term capital gains tax rates are typically higher than long-term capital gains rates. (Your brokerage account will likely indicate the exact number of shares of any investment you purchased, and the date you bought or sold it on your statement or online account profile). As a result, the experts at WealthFront say that younger investors who have a long time horizon for their investment strategy, and who contribute consistently to their investment portfolios for many years are most likely to reap the long-term savings benefits tax loss harvesting offers.
What tax bracket will fall into in 2016?
When you have a sense of your 2016 tax bracket, you can better predict how much tax loss harvesting could impact your taxes owed—especially if offsetting gains keeps you in a lower tax bracket.
In 2016, single filer taxpayers with income between $37, 651 and $91,150 fall into the 25% tax bracket for ordinary income and short-term gains. But single filers who earn between $91,151 and $190,150 in income in 2016 are in the 28% tax rate for ordinary income, and short-term capital gains. Through tax loss harvesting, a taxpayer who is close to either bracket’s earning threshold could potentially offset short-term gains with losses, and remain in the lower tax bracket.
What gains and losses can you leverage?
Short-term gains are taxed at a higher rate than long-term gains. Taxpayers most benefit by applying them to losses first—but it’s not always legal to do so, based on the tax code. Tax law specifies that taxpayers must apply like losses to offset like gains of the same type first. For example, short-term capital losses must apply to short term capital gains, and vice versa with long-term losses/gains. However, tax code does allow taxpayers to apply outstanding losses to outstanding gains that aren’t of the same type.
If a taxpayer has $5,000 remaining in long-term losses but no more long-term gains, for example, she could apply the amount of the loss to offset some of her short-term gains. Taxpayers can also carryover losses and apply up to $3,000 a year in capital losses to reduce ordinary income, until all losses have been claimed.
Though tax-loss harvesting more than once a year could help investors take advantage of some losses that occur with market downturns, it’s important to be certain you’re ready to part with an investment if the goal is to leverage the loss. The wash-sale rule says that investors who sell a security—or a “substantially identical” security—cannot buy it back within 30 days. If they do, they’ll lose the tax-related benefits associated with the loss. If you want to invest in the same type of security you sell for tax-loss harvesting purposes, look into an ETF that tracks a similar index as the sold security; it’s not considered an identical investment.