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How to Use Your Losing Stock Positions to Lower Your Tax Bill

Taking losses to offset capital gains can prove to be a smart strategy come tax time.

(Bloomberg) -- It’s hard to think of many upsides to selling a stock at a big loss, but there is one: It may lower your taxes.

Investors who take a loss in a taxable account can use it to offset capital gains taxes owed from selling stocks that have appreciated. Such tax-loss harvesting usually gets talked about at year-end, when people strategize about how to offset realized gains. But the S&P 500’s descent into a bear market has pushed the conversation up this year.

“If you have capital gains you want to offset — maybe from a stock you’ve held for years —and have losses from the last six to 12 months to offset that, it would be a good use of tax-loss harvesting,” said Jeffrey McDermott, a financial planner with Create Wealth Financial Planning.

The recent slump in markets has made it an appealing strategy. Robo-adviser Wealthfront, which offers automated tax-loss harvesting, said the volatility led its program to harvest more losses in the first half of June than it did from July to December combined. 

An investor who harvests a loss can not only use it to offset capital gains, but can use any leftover amount to offset $3,000 of ordinary income. After that, any remaining loss can be carried forward to offset gains or $3,000 of ordinary income in a future year. 

Many robo-advisers offer automated tax-loss harvesting, including Betterment, Wealthfront, and, for those with higher balances, Schwab Intelligent Portfolio and Personal Capital. 

Backend Benchmarking, which tracks robo-advisers, said in its 2021 Tax-Loss Harvesting Study that programs can vary greatly between advisers. “While some realized net losses of over 8% of the account value on the year, others did not realize any losses at all,” the report said. Schwab Intelligent Portfolios “stood out for the highest percentage of realized net losses for the year,” the study said.

Wash-Sale Rule

The complexity comes in when an investor realizes the loss, but also wants to maintain exposure to the industry of the stock they sold. This is where you have to be careful not to run afoul of the Internal Revenue Service’s “wash-sale rule.”

The wash-sale rule says that if you’re going to deduct a loss, you can’t turn around and buy a “substantially identical” stock or security for 30 days up to the date of sale, and 30 days after. If you do, the deduction may be disallowed.

It’s easy to figure out what’s “substantially identical” with stocks. If you deduct a loss for Netflix, you can’t go out and buy Netflix immediately afterward. “Where it gets complicated is if you sold a stock, then bought a call option on it,” which gives the right to buy a stock at a certain price in the future, said Tim Steffen, director of tax planning at wealth manager Baird Private Wealth Management. “From the IRS standpoint, that’s substantially identical.”

A more common situation is with the sale of an actively managed mutual fund or exchange-traded fund.

“If you buy one growth fund and sell another, if they’re actively managed we are pretty comfortable with that, since they’ll have different expenses, different holdings,” Steffen said. 

With passively managed index funds, your risk may also be relatively low. But you can’t sell a Vanguard fund tracking the S&P 500 at a loss and then buy a Fidelity fund tracking the same index, even if a detail like the expense ratio differs.

Index funds can be helpful with tax-loss harvesting in another way. If you’re selling a stock to take a loss, such as Meta Platforms Inc., but want to maintain exposure to the industry, you could buy a mutual fund or ETF that tracks a technology index that owns Meta. 

A few tax wrinkles to remember if you don’t use an adviser, human or otherwise: Wash-sale rules don’t allow for a husband to sell a stock, and for his wife to buy it right back. You also can’t sell a stock in a brokerage account for a loss, and then buy it in an IRA.

One area of the market not subject to wash-sale rules? Crypto. From a tax standpoint, crypto is considered property, rather than a security. So people can realize crypto losses, take a deduction for taxes, and buy it right back. “You can have the government partially subsidize your loss in Bitcoin,” Steffen said. 

To contact the author of this story:
Suzanne Woolley in New York at [email protected]

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