Obviously, your situation is going to differ depending on how you’re currently invested. But if you’re sitting on losing stocks, you have until the end of the year to sell them and finish writing off losses during 2014, when it comes to tax returns due next April. When it comes to IRAs and 401ks, it’s a different story. You can’t deduct the losses on your taxes. But on your regular accounts, you can offset any loss you take versus any gains you’ve made on the investments. But again, you have to do it for the calendar year ending December 31st.
Be careful of so-called IRS wash rules. What that means is if you have a losing investment in your account—say a stock—and you sell it, you’re not allowed to repurchase it for 30 days after selling it. The context of this is yesterday I was telling you that you have until 12/31 to realize any losses on stocks, to be able to deduct those losses (or offset any gains) against the profits you have in your non-retirement accounts. But the wash rules say you can’t buy back that investment, for 30 days after selling it. That’s to keep people from obviously selling a loser just to get the tax break, and then immediately buying it back. So know the wash rules, or speak to your financial advisor about it… BEFORE selling any investments for year-end.
So currently, the IRS says if you have a losing stock, for example, and have held it for more than 12 months—like a lot of people have—you can ONLY deduct up to 3,000 dollars in losses. So let’s say you bought a bunch of Citigroup stock back in 2000. And you’re down 10,000, 20,000 dollars or more, which is not unusual. You’re tired of holding it, and you want to sell to take the tax loss this year. When you go to file your taxes, the IRS is only going to allow you to deduct 3,000 dollars of that loss against your income for 2014. The rest of the loss, you carry forward to coming years, to deduct each of those years. 3,000 dollars it the max capital loss deduction. The smart thing to do is take some winning stocks, sell them to say, a 3,000 dollar gain, and then you’d owe nothing to the IRS in terms of capital gains.
Tax harvesting is a fancy term meaning to selectively take investments you own that are profitable, and offset them with losing investments, to essentially make a wash on the taxes you owe. There’s a lot of tedious rules the IRS has in play, such as wash sale rules I mentioned yesterday. So you want to consult with your financial advisor and tax consultant. Some questions you’ll want to discuss: Will the tax losses you’re planning to net against be short-term or long-term capital gains? Also, what offsetting winners will you harvest to put against your losers, resulting in a net zero tax liability. There are other questions also, including what the impact on your portfolio will be, what the allocations of investments will become, and so forth.
5Checking Your Balance
Since you’re going to be looking at tax harvesting—matching losing stocks against winners, for no tax liability (or a reduced liability, I should say)—make sure you’re also looking at the impact of this on your portfolio balance. In other words, if you start selling off stocks to realize losses, what does that meant to your allocations to equities? Are you now underbalanced there? Overbalanced in cash? What? So any discussions of tax harvesting in an account MUST include a discussion on portfolio strategy and asset allocation. Or in my case, asset re-allocations. It’s an important consideration to take into account, BEFORE you ever attempt to sell an investment just to realize the tax loss. There you go.