Profiting off your investments while also reducing your tax bill is a delicate balancing act. The more you learn about tax reduction strategies, the clearer it becomes that timing is essential to keeping taxes low. Putting these strategies into play requires advance planning, which is where the help of a Certified Tax Planner comes in handy. With expert assistance, you can identify the approach that best fits your financial situation. In this blog, we’ll cover two strategies that can turn a downfall into a win: loss harvesting and loss carryovers.
The goal of loss harvesting is to offset your capital gains—the profit you make from selling a property or investment—with unrealized losses. You may have an unrealized loss if you bought an asset, and now that asset’s fair market value is below what you paid for it. If you opt into this approach, keep in mind that you cannot sell an asset at a loss, claim a tax deduction for that loss, and then immediately turn around and repurchase that asset. The IRS has rules in place to prevent taxpayers from falsifying a loss just to get the tax break.
That limitation is also known as the “wash-sale rule.” Specifically, the IRS prohibits taxpayers from selling an investment for a loss and replacing it with a “substantially identical” investment within 30 days of the sale—either before or after the date of sale. If you do intend to replace that asset in some way, be conscious of avoiding the wash sale limitation. If you sell an investment in a security, you may be able to buy securities of a different company in the same type of industry or shares of a mutual fund in that same type of industry. Similar investments do not meet the “substantially identical” test. Consult an expert if you are unsure before making the purchase!
Alternatively, you can simply wait for 31 days before buying a new investment. Though this takes a bit more planning, you can also preemptively make the new purchase at least 31 days before you plan to sell your old stock. Let’s say you have stock you have been meaning to sell for a while. Rather than waiting to buy your “replacement” stock, you could go ahead and make your purchase, say on May 1st, and then wait the allowed 31 days before selling the unwanted stock, say on June 1st. The mistake many people make is waiting until they have already received the capital gain to try to actualize a loss to mitigate the tax impact.
Though we won’t get into a discussion on cryptocurrency here, take note that at this time the wash-sale rules do not apply to crypto transactions. So it is possible to have a wash sale with cryptocurrency, lock in your capital loss, and immediately repurchase that same cryptocurrency. Of course, legislation may change to address this, so you will want to keep an eye out for recent updates before making a sale—but for now, you might benefit!
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Loss carryovers are true to their name—this rule allows taxpayers to carry a tax loss over to a future year to offset a profit rather than recognizing the loss in the year it occurs. If you have more losses than gains, you are allowed to deduct up to $3,000 per year (or $1,500 for married filing separately). You can continue to do so over multiple years until the full amount of that capital loss has been deducted.
This rule allows you to offset various types of income, including wages, self-employment, and business income. Loss carryovers can continue until the taxpayer’s death but cannot be passed on to an heir.
Loss carryovers are a great example of the impact of proactive planning on your total tax liability. To take an example, let’s say that you own a rental property that has increased in fair market value since you purchased or inherited it. Let’s also say that one year you have sizable capital loss carryovers available from stock market or cryptocurrency losses. If your rental property has an unrealized gain, it might be time to sell that property, since you have losses to offset the profits. You might even purchase a new piece of property, giving you a higher depreciable basis. Then your ongoing income from that rental activity can pay a lot less in tax on that income.
If you are looking for a tax deduction, check on the possibility of unrealized capital gains. Think back to whether you may have purchased some assets, say some stock investments, but now you have stopped actively paying attention to it, assuming that it will do well and generate income. The question is whether that asset is making money on its own, or if it’s not doing well, it could be put to better use as a loss harvest or loss carryover.
Financial losses can end up providing a benefit when it comes to tax planning. With some advance planning, loss harvesting and loss carryovers can be leveraged to lower your tax bill in years when you have more income coming in from other sources. Again, timing is key to make these strategies work for you. To start working on the best tax plan to match your investments, reach out to a Certified Tax Planner today.