With stock prices falling, consider ‘tax-loss harvesting’ to stay invested
When share prices fall, and losses occur, there can be an opportunity to reduce your taxes.
U.S. stock prices have significantly dropped over the past week and — thanks to changing government policies and other factors — many experts are predicting more volatility in the months to come.
That’s certainly bad news for investors. But there is a silver lining. When share prices fall, and losses occur, there can be an opportunity to reduce your taxes. It’s called “tax-loss harvesting,” and it’s a tactic that may be worth considering this year.
According to Malvern-based financial firm Vanguard, “tax-loss harvesting is when you sell investments at a loss and use those losses to offset gains in other investments. You then take the money from the sale and use it to buy an investment that fills a similar role in your portfolio, so you stay invested in the market.”
“Tax-loss harvesting can be an effective strategy when it aligns with your long-term investment goals and overall financial plan,” said Mitchell Gerstein, a senior tax adviser at Isdaner & Co. an accounting firm based in Bala Cynwyd. “This approach helps maintain a tax-neutral position while keeping your portfolio on track.”
Here’s how to take advantage.
Offset gains with losses
For starters, if you do sell stocks this year for a gain, you can offset those gains with the losses incurred when you sell other stocks at a loss. Another bonus: If your losses are greater than your gains, you can offset up to an additional $3,000 per year (depending on your filing status) against your ordinary income too.
“Losses offset capital gain distributions reported on Form 1099-DIV, which are paid out by mutual funds and, to a lesser extent, index funds when investment managers sell long-term holdings for a profit,” Gerstein said. “Also, be aware that taxpayers with a modified adjusted gross income (MAGI) exceeding $200,000 for individuals or $250,000 for joint filers may be subject to a 3.8% surtax, known as the Net Investment Income Tax. This tax is calculated based on your MAGI and total investment income, including capital gains.”
Robin Wagner, an independent certified public accountant in Bucks County, said that selling stocks, even at a loss, can give you the opportunity to rebalance your portfolio and force you to shift into a different (hopefully better) investment.
“If a stock or sector is overweighted and underperforming, selling can improve diversification while gaining tax benefits,” she said. “You also stop the bleeding if that stock is doing poorly, and you sell it, you limit additional losses you might experience.”
Move into a lower tax bracket
The more you’re able to offset your losses against your gains — and even take advantage of the additional $3,000 deduction — you may be able to keep your income at the same tax bracket, or even move yourself to a lower tax bracket and pay less taxes.
You can also carry forward these losses indefinitely to offset any future gains.
“‘The carry forward’ is something that many accountants might miss, especially if the client is a first-time client for that accountant,” Wagner said. “This is why having the previous year tax return is so important, to make sure you grab any carryover losses.”
Take advantage of ‘wash’ sales
If you’d like to take advantage of the tax benefits by selling a stock at a loss — but you still think it can gain in the future — there’s a way to do this too. It’s called a “wash” sale. In this scenario, you sell the stock and then buy it back after 30 days. This way you can deduct the loss and still own the stock long-term.
“The wash sale rule also applies to IRA accounts,” said Joseph Hare, a certified public accountant and tax expert in Media. “While the wash sale rule doesn’t apply to transactions completely within an IRA, it does apply if you sell a security at a loss in a taxable account and then buy the same security in an IRA or your spouse’s.”
Dayna Carr, a financial professional based in Doylestown, said that this strategy does have risks.
“If it’s a temporary dip, you risk missing a recovery — think of the COVID stock market rebound — and buy back in at a higher price,” she said. “Selling at a loss and reinvesting in another may create unnecessary risk, and it may be better to hold cash and reinvest for a safer investment later.”
Carr advises to be careful you’re not doing this for the wrong reasons.
“Selling an investment should align with your financial strategy and not just be tax driven,” she said.
Know the limits and talk to your advisers
Gerstein agrees and warns that there are limitations to tax-loss harvesting, including potential higher transaction costs from frequent trading, such as commissions and fund expenses. Additionally, investors in lower tax brackets or those with minimal capital gains may see limited benefits since their tax liability is already low.
“This strategy should complement your broader investment strategy rather than drive decisions purely for tax benefits,” he said. “Consulting a financial adviser can ensure you implement this approach effectively while maintaining focus on long-term financial success.”
Carr said that there can also be a psychological impact to selling stocks at a loss.
“It can feel like you are locking in failure leading to an emotional decision-making rather than strategic investing,” she said. “Try to leave emotions out of it. Do not sell just because others are. When the market is down, use cash on hand to buy time-tested investments. Sell when the market is high for profit. Your CPA and financial planner can be your best friend when you’re emotional.”