Taking profits off the table ahead of the holidays means thinking about capital gains taxes for 2022 and strategies to minimize the tax burden like tax loss harvesting.
An improving economy in 2021 after a pandemic-ridden 2020 saw the major stock market indexes reach highs, giving investors reasons to celebrate. For short-term gains, however, taxes can surely dampen the holiday spirit.
Nonetheless, investors can start employing tax loss harvesting now before 2021 comes to an end. Fortunately, Invesco offered an easy-to-follow discussion on tax loss harvesting — something that’s not easy to do when it comes to explaining taxes.
“This step is as simple as it sounds: Sell an underperforming investment — could be an individual stock, a mutual fund or an exchange-traded fund — for less than you bought it,” Invesco explains.
It’s very similar to a professional sports team tanking on purpose in order to obtain a higher draft pick. (Of course, they’ll never admit to that.) Tax loss harvesting works much the same way — taking strategic losses in order to minimize the tax bite of previous gains.
However, investors need to know about the nuances of tax loss harvesting before diving in.
“Here’s where losses can potentially help: You can use your losses to offset gains on other investments, helping to reduce your tax obligations,” Invesco says. “Don’t have any gains? That’s OK! You can still use losses to offset the taxes on your ordinary income, up to $3,000 in the current year.”
Losses in excess of over $3,000 could be carried over into future tax years, Invesco notes. This can be done in $3,000 increments, which, in essence, is also known as deferring.
Another aspect of tax loss harvesting is replacing the investment. Invesco uses the example of selling a tech stock and replacing it with a tech-focused exchange traded fund (ETF) if that investor wants to maintain that sector exposure.
“If you sell a security and harvest a tax loss on that sale, the Internal Revenue Service (IRS) prohibits you from buying a ‘substantially identical’ security within 30 days before or after the sale of your losing investment. (This is called the ‘wash sale’ rule),” Invesco explains further.
Of course, when it comes to something as complicated as taxes, it’s always best to consult a professional.
“If you’re faced with an underperforming investment, talk to your financial professional and your tax advisor to see if tax loss harvesting is a good idea for you,” Invesco advises.
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