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Tax-Loss Harvesting

As we approach the end of the year, please be aware of something called “tax-loss harvesting.” An investment loss (in a non IRA account) can be used for 2 different things:

1. The loss can be used to offset investment gains.
2. The losses can offset up to $3,000 of income on a joint tax return in one year. Unused losses can be carried forward indefinitely.

Poor markets, like 2007-2009 are a good example. Your losses from stocks may insulate your taxable gains of several years. Below are some rather important details to know with respect to tax-loss harvesting:

There are 2 types of gains and losses: short-term and long-term. Short-term capital gains and losses are those realized from the sale of investments owned for a year or less. On the other hand, long-term capital gains and losses are realized after selling investments held longer than 1 year.

The key difference between them is the rate in which they are taxed. Short-term capital gains are taxed as ordinary income which can be as high as 37%. On the other hand, long-term capital rates are significantly lower. The rate depends how you file AND your taxable income. It can be as low as 0% and as high as 20%. This needs to be checked with your tax advisor.

Harvest Losses To Maximize Tax Savings

When looking for tax-loss selling candidates, consider investments that no longer fit your strategy, have poor prospects for growth, or can be easily replaced by other investments that fill a similar role to the investment you are getting rid of. Focusing on short-term losses provides the greatest benefit because they are first used to offset short-term gains which are taxed at a higher rate.

According to the tax code, short-term and long-term losses must be used first to offset gains of the same type. However, if your losses of one type exceed your gains of the same type, then you can apply the excess to the other type. As an example, if you were to sell a long-term investment at a $20,000 loss but had only $5,000 in long term gains for the year, you could apply the remaining $15,000 excess to any short-term gains.

On the other hand, if you have harvested short-term losses but have only unrealized long-term gains, you may want to consider realizing those gains in the future. The least effective use of harvested short-term losses would be to apply them to long-term capital gains. The tax code allows filers to apply up to $3,000 a year in capital losses to reduce ordinary income, which is taxed at the same rate as short-term capital gains.

Should you wish to discuss this further, please call us at 305-670-7088.

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