You can lower your tax burden when you sell stocks or bonds at a loss by offsetting the losses with capital gains.
Unless you’re someone who shorts stocks, falling stock prices, like the one we experienced last year, is likely to be quite painful.
But there is a way to lessen the pain a bit. It’s called tax loss collection. The idea is to sell the worst of their properties: the biggest dogs. This assumes that you are selling the stock at a loss.
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You can then use your total capital losses to offset your capital gains for tax purposes. If your losses exceed your gains, you can use up to $3,000 of the excess to offset your ordinary income for tax purposes.
If the excess is more than $3,000, you can carry it over to future years. Each year you can use all your losses to offset your gains. And if the losses outweigh the gains, you can again use up to $3,000 to offset ordinary income.
Depending on the amount of your capital gains and losses, the savings could be substantial. And then, if you apply $3,000 against your regular income, you get a little extra savings. Someone in the 22% tax bracket would save $660.
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Example of tax loss collection
Here is an example that may help you understand the concept. Let’s say you sell some investments for a loss of $30,000, but others for a gain of $25,000. Your losses would offset all your gains for tax purposes. And you would have $5,000 left over in losses.
You could use up to $3,000 of that to offset your ordinary income, and you could keep the remaining $2,000 to use in future years.
The tax savings would be $4,410, assuming a long-term capital gains tax rate of 15% and an ordinary income tax rate of 22%.
Given the recent rollercoaster in financial markets, now is a good time to think about tax loss collection, wrote Brian Concannon, head of digital advisors and advice to the massively rich at Vanguard, in an exclusive commentary for TheStreet.com.
Taking advantage of a falling portfolio
“It’s never easy to watch your portfolio lose value,” he said. “During periods of market volatility, tax loss collection gives many investors the opportunity to take advantage of that volatility and benefit from realizing losses that can be used to reduce their taxes in the future.”
Note that you can implement tax loss collection for bonds and other securities, in addition to stocks.
You can use tax collections to help rebalance your portfolio if your asset allocation is out of whack, Concannon said. So if you’re overweight in stocks, you can sell some of the dogs to reduce the weighting and get a tax break in the process.
You certainly don’t want to use the strategy just anyhow. You may own depressed shares of a company that is fundamentally strong.
You wouldn’t want to sell it just for a tax benefit. You are likely to enjoy a much larger profit if the stock eventually rallied in the long run.
