When pundits talk about market performance in 2022, a common word they will throw around is volatility. Markets have ridden a rollercoaster in recent months, with much of the trend pointing downward as the U.S. economy confronts rising interest rates, increased inflationary pressure and a number of unsettling global events. And that volatility may be here to stay for the remainder of the year as mid-term elections loom this November.
But not all is lost. Even when the market turns into a scowling bear, investors who own taxable investments – brokerage accounts where dividends, distributions and capital gains are taxed in the current year – can take steps to help manage, and potentially reduce, their annual income tax obligation. Specifically, tax-loss harvesting is a strategy used to sell securities at a loss. While this may not sound attractive on the front end, the tax planning opportunities can be a boon.
Take the current year’s market as an example. As of this writing, the broad U.S. indices have been down by double digits, with the Dow off almost 9 percent, the S&P 500 giving up nearly 12 percent and the NASDAQ dropping by more than 18 percent. For investors who hold funds or individual stocks in these indices, however, all is not lost.
By selling a fund or security at a loss, investors can capture that loss through tax-loss harvesting and use it in one of three ways to offset income tax liabilities:
- If an investment is sold at a loss, you can use that capital loss to offset any capital gains realized in that tax year.
- If the loss exceeds capital gains realized, it can be used to lower your ordinary taxable income by up to $3,000 that tax year.
- If you still have loss remaining after those two steps, the loss can be carried forward indefinitely to offset future capital gains, or up to $3,000 annually of ordinary income, for the life of the taxpayer.
By harvesting losses, investors can take the sting out of market swings and provide tax benefits that may last for years. Talk to your advisor about this opportunity before taking action. If done incorrectly, captured losses can be negated, specifically if the investor instigates the wash-sale rule by investing in the same or similar investment too close to the date of the sale.
Tim Neuenschwander, CPA, CFP® is the managing member of Neuenschwander Asset Management, LLC. You can click on his name to visit his LinkedIn profile or you may contact him via email at firstname.lastname@example.org.