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For a variety of reasons, such as higher interest rates, rising inflation and supply chain issues, the financial markets were volatile in 2022 — and this volatility probably showed up in your investment statements. Yet, while you may have been less than happy about your investment returns this year, the volatility and depressed prices may offer you some opportunities at tax time.
Specifically, you may be able to take advantage of tax-loss harvesting. Using this strategy, you sell securities at a loss to offset capital gains, which you may have if you’ve held some investments for years and they’ve greatly appreciated in value. And if your total losses exceed your gains, you could offset up to $3,000 of ordinary income per year and carry over the rest to future tax years.
Tax-loss harvesting isn’t just a tax issue — it also can be part of your investment strategy. What investments should you sell to take the capital gains? Which ones should be sold to take the losses?
To answer these questions, consider a few different factors:
- Diversification – Portfolio rebalancing is important for investors. If you have too many investments that have essentially the same characteristics, your portfolio might be under-diversified — and diversification is necessary to help you achieve your long-term goals. If your assets are concentrated in a single asset class or a single stock, your portfolio could take a big hit during times of market volatility, but a diversified investment mix can reduce this impact. Consequently, when looking at ways to take advantage of tax-loss harvesting, you could consider selling an investment that’s similar to several others you may own. (Keep in mind, though, that diversification can’t prevent all losses or guarantee profits.)
- Performance – Investment performance can be looked at in a couple of different ways. If you’ve held an investment for many years and it has gone up greatly in value, you might be motivated to sell it and take the profits. Conversely, if you have an investment that’s consistently under-performed and has lost value, you might feel you’re better off selling it and applying the losses against capital gains.
- Holding period – When you sell investments that you’ve held for a year or less, your gains are taxed at your ordinary income tax rate; for investments held longer than a year, you’ll pay the long-term capital gains rate, which is based on your income and ranges from 0% to 23.8%, which includes a 3.8% net investment income tax for high earners. Short-term losses offset short-term gains first, while long-term losses offset long-term gains. Once losses in one category exceed the gains of the same type, you can use them to offset gains for the other category.
Here’s one more point to keep in mind: If you want to sell an investment for tax purposes, but you might like to reacquire it, you’ll have to meet the “wash sale” rule, which prohibits you from writing off an investment loss if you or your spouse buys the same investment, or a substantially identical one, in the 30 days before or after the sale.
To take advantage of tax-loss harvesting, you’ll need to act before the end of the year. And consult with your tax advisor. This strategy can be effective — but you’ll need to be sure it’s right for you.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor.
Edward Jones. Member SIPC.
Sean Payne, CFP® can be reached at (562) 596-3722.
