By Ryan Martin and Lauren Hunt, Senior Advisors
Investors know the drop in stock prices for many companies and funds in 2022 has hurt their portfolios. Even historically stellar investments have tumbled this year. For example, Apple Inc., which reached a 52-week high of $182.94 on January 4, had lost nearly $30 per share by the end of October.
While no investor likes to lose money, there is a way to take advantage of these losses to reduce 2022 (and possibly future) taxes.
By selling one or more investments that have lost money, an investor can potentially reduce their taxes. Often referred to as ‘tax loss harvesting,’ this tool can be applied to any losses that occur from money invested in a taxable brokerage account. Unfortunately, losses from investments that are held within tax-deferred accounts, such as 401(k) retirement or Individual Retirement Accounts, cannot be used. Capital losses will offset capital gains and if there are no gains to offset, the losses will offset up to $3,000 per year in ordinary income. Losses that exceed gains (and after the $3,000 ordinary income offset) are carried forward on your tax return and they can/will offset future capital gains.
There are some Internal Revenue Service rules governing this practice to ensure investors don’t illegally avoid paying taxes. For example, an individual can’t sell a stock one day to capture a loss and buy back the same stock at a much lower price the next day. However, they can reinvest the money from the sale into a different stock or stock fund that meets their investment needs and asset-allocation strategy. This avoids sitting on the sidelines for 30 days, which is the timeline in place to avoid running afoul of the IRS ‘wash sale’ rules.
Here’s a good example of how tax loss harvesting can benefit an individual investor:
A person has invested $60,000 in Large Cap Growth Fund “A.” The fund has lost $10,000 this year and is now worth only $50,000. This investor could consider selling the entire fund and take a loss of $10,000.
If that occurs, the $50,000 could be reinvested into Large Cap Growth Fund “B.” This fund is a similar option since it invests largely in large-cap growth companies such as Microsoft, Amazon and Netflix. However, by placing the money in a different fund which is not substantially identical, the IRS wash sale rules are not called into question. Meanwhile, this strategy enables the reinvested money to work for the investor in case the market quickly moves up.
Here’s where the tax savings comes in. Assuming the loss of $10,000 directly offsets $10,000 of long-term capital gains, a person would likely save between $1,500 and $2,000 on their federal income taxes (and possibly more if also subject to net investment income taxes). Of course, each investor’s situation will be different depending on their specific tax return and capital gain income tax rates.
Benefits of Working with Moneta’s Team of Advisors
Before any sale occurs, we work with each investor to ensure selling a stock or fund is the right strategy. While every situation is different, we generally look for capital loss opportunities of significance, so we are not constantly trading in and out of funds. Depending on the size of a person’s portfolio, a rule of thumb might target losses in excess of $1,000-$2,000 and/or 5% or more on a percentage basis.
We realize many investors may be concerned about moving money from a particular company or fund that has generated significant returns over many years. That’s where we rely on Moneta’s investment manager due diligence. They will evaluate the choice of funds and reinvest money into a fund that is similar but not substantially identical to the one where the sale has occurred. And, if the investor prefers to be in their original investment, our team will work with them to consider placing some or all of the money back into that investment 31 days after the sale.
While tax loss harvesting can be done at any time, it is something folks often consider near the end of a calendar year as part of an overall tax planning strategy. To learn more, please contact us at rmartin@monetagroup.com or lhunt@monetagroup.com. We offer a free consultation to discuss how a comprehensive tax planning and asset allocation strategy can enable your wealth to grow.
© 2022 Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment advisor does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified. Trademarks and copyrights of materials referenced herein are the property of their respective owners. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.
