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Using Investment Losses

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Capital gains on investments held for one year or less are short-term capital gains taxed at ordinary income tax rates. For investments held over one year, the maximum long-term capital gains tax rate in 2010 is 15% (0% for taxpayers in the 10% or 15% tax bracket).

At the end of each year we generally review our client’s taxable accounts in search of tax losses to harvest. Some issues to consider:

Recognize losses to at least offset $3,000 of ordinary income. Capital losses offset capital gains. Losses in excess of gains can be used to offset up to $3,000 of ordinary income. Any additional excess capital losses can be carried over to offset gains and/or ordinary income in future years. If you are holding stocks, ETFs, mutual funds or other investments with losses in your portfolio you should consider taking advantage of this tax rule.

Make sure to avoid the wash sale rules. If you still want to own the investment with the loss, you can sell the investment, recognize the tax loss, and then repurchase the holding. You just have to make sure to avoid the wash sale rules. These rules state that you must repurchase the shares at least 31 days before or after you sell your original shares to recognize the loss for tax purposes.

Recognize the loss and buy a something similar to maintain your desired portfolio allocation. Let’s say you have a loss in the Vanguard 500 Index fund, yet you want to maintain a passive large cap position in your portfolio. If you sell the Vanguard 500 and buy the Schwab Index 500 fund you have violated the Wash Sale Rule. However if you were to buy the Vanguard Total Stock Market Index Fund or the ishares Russell 1000 ETF you would be purchasing a fund or an ETF that is highly correlated to the Vanguard 500 but that tracks a substantially different index.

Consider recognizing all, or a substantial portion, of any losses in your portfolio. Understanding that no one likes to sell investments at a loss, recognizing losses now provides flexibility when recognizing gains in the future. Until you use all of your capital losses, you can recognize capital gains without worrying about paying taxes. Even if your losses are long-term, you can use them to offset short-term capital gains. Remember capital gains distributions from mutual funds can be offset here as well.

Year-end is always a good time to review and rebalance your portfolio. Tax-loss harvesting should be a part of this review. While nobody likes to realize losses, the focus should be on your overall portfolio and not on the individual components. The ability to recognize tax losses and to use them to offset future gains is an excellent way to ensure that tax considerations do not play into portfolio rebalancing decisions.

Like all issues in the realm of financial planning this one is not a no-brainer.  Please consult your tax or financial advisor before embarking on tax-loss harvesting.

Please feel free to contact me should any questions arise as you review your holdings.

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Comments

  1. Thank you for this. I need to offset some income that was not taxed and didn't know how much stock trading losses would impact my income. It's actually going to come in handy!

  2. Sandy thank you for your comment and glad you found this post to be helpful. As always take these articles as guidance but not advice on your individual situation.

  3. Thanks for the reminder. Best Buy is getting a thorough review this week!

  4. Thanks for your comment Barb. I don't follow Best Buy but I heard they took a bit of hit based on their last earnings report.

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