With the market’s volatility during 2020, you may have some positions that are currently valued below what you paid – a situation known as an “unrealized loss.” A good practice to evaluate before year end is to check to see if you have positions such as these that may be sold to offset gains you’ve taken in other securities, thus reducing your tax liability. This practice is called “tax loss harvesting.”
For tax purposes, all short-term gains and losses are first netted against each other. Similarly, long-term gains and losses are netted against each other. Then, these two figures are combined to determine the overall net short-term or net long-term gain or loss. If the resulting figure is a loss, you can take up to an additional $3,000 of capital losses against ordinary income on your federal tax return. Any remaining losses may be carried forward to the next year.
Once you sell a security you will need to evaluate how to invest the proceeds and it’s important to be aware of the “wash sale” rules. These stipulations restrict you from purchasing the same or substantially similar security within 30 days of the sale of the original investment and recognizing the loss – this includes the period 30 days prior to the sale, and 30 days after the sale. Therefore, if you’d like to purchase the same security while avoiding violation of the wash sale rule, you can wait 31 days and then repurchase the same security, or you can “double-up” by buying more of the security now, and wait 31 days to sell the original investment. The last day to double-up during 2020 is November 30. Another way to avoid the wash sale is to invest in a different but similar company or industry, thus avoiding the “substantially similar” requirement within the wash sale rule.
A few other takeaways to consider when evaluating tax loss harvesting:
- Before making any changes, it’s important to make sure your portfolio is aligned with your goals.
- Trade date is used when determining your holding period, not the settlement date.
- Managing taxes can be complicated, so it’s important to consult with your tax professional for guidance tailored to your specific situation. Please remember, Benjamin F. Edwards does not provide tax advice.
- While year end is typically when people consider this strategy, it’s something to evaluate throughout the year.
Investors should also be aware of the potential for capital gains distributions from mutual funds, even if they don’t sell them. The long-running bull market has resulted in strong mutual fund capital gains in recent years and many sectors of the market are higher again in 2020.
If you need help evaluating your capital gains and losses for the year, contact a financial advisor for assistance.