Save on Taxes in a Negative Calendar Year

With both the stock market and fixed income market well into the red for the year, the capital loss deduction should be heavily utilized this upcoming tax season.

How it works

A net capital loss occurs when realized capital losses exceed realized capital gains for the year. The key here is that a position has to be sold for the gain or loss to be realized. For example, if you bought a security but haven’t sold it, the gain or loss is still unrealized.

The capital loss deduction allows you to deduct from your other income the amount of your net capital loss up to a $3,000 limit each year ($1,500 if married filing separately). If your loss is over $3,000, you can carry the unused portion over to a future tax year as if it was realized then (this is called an unlimited loss carryforward). It can be wise to offset future year’s capital gains with those loss carryforwards.

Does this apply to you?

This provision can be used for taxpayers who have a taxable investment account with realized losses exceeding realized gains. Assuming that the majority of investors’ portfolios are down for the year, you simply sell the desired position(s) to generate a realized loss for the year. Keep in mind that retirement accounts like IRA’s and 401(k)’s grow tax-deferred so this provision would not apply to losses taken in those accounts.

Be careful before selling your investments

When you sell your loss position(s) you benefit from the immediate tax savings. However, you are also forgoing the future return and potential upside of the investment you once believed in (and maybe even still do). You have effectively bought high and sold low!

At THOR, we believe tax ramifications are of secondary importance to the actual investment. For example, let’s say you are a week away from getting capital gain treatment on a position that has appreciated over time. But trouble looms and you expect the position to fall significantly and abruptly. We don’t think it would be wise to stay in the position and take the brunt of the fall solely for the favorable tax treatment. On the contrary, it would also be foolish to sell a stock that is negative now, but still a fundamentally strong company just so you can save a few hundred* bucks on taxes (*keep in mind this is a $3,000 deduction to your income, not a $3,000 tax credit).

And don’t try and think you’re one step ahead of the IRS and can do both (i.e., sell the position, save on taxes, and then buy right back into the security). The wash sale rule was created for this very reason – preventing taxpayers from capturing those artificial tax breaks while essentially maintaining their position in the investment.

In the end, this tax-loss harvesting strategy can cause conflicting interests between your short and long-term benefit. In our opinion, it is important to do what is best in the long run, rather than trying to save every dollar you can on your taxes in the short-term. For these reasons, it is always a good idea to coordinate a discussion with both your advisor and your accountant to weigh your options.