A Tax-Reducing Trick That Could Trip You Up

[RV_]

I was about to make this mistake as I have a total loss of $3k and was going to reinvest in a similar penny stock. I am glad I saw this today as I was about to make buy sell changes for our taxes that can wait the month required to not lose the deduction.

Excerpt:

"Watch Out for Wash Sales

Getting a tax break when you sell a losing investment—better known as tax-loss harvesting—is one of the few upsides of dumping an underperforming asset. So, you wouldn't want to lose that tax break by falling afoul of an IRS rule governing "wash sales."

In short, a wash sale is when you sell a security at a loss for the tax benefits, but then turn around and buy the same or a similar security. It doesn't even need to be intentional. For example, if you sold only part of a position for tax-loss harvesting purposes and then had reinvested dividends, you could lose some of your tax break.

Here we'll answer some common questions about the wash-sale rule.

Q: How does the wash sale rule work?

If you want to sell a security at a loss and buy the same or a substantially identical security within 30 calendar days before or after the sale, you won't be able to take a loss for that security on your current-year tax return. However, there are some compensations: You will be able to add the amount of the loss back onto the cost basis of the replacement security, which can help with taxes later, as we'll see below. In addition, the holding period of the original security gets tacked onto to the holding period of the replacement security.

Here's an example:

Let's say you buy 100 shares of XYZ stock for $10 per share ($1,000 of stock). One year later, the stock starts dropping, so you sell your 100 shares for $8 per share—a $200 loss. Three weeks later, XYZ is trading at $6 per share and you decide that price is too good to pass up, so you repurchase the 100 shares for $600. This triggers a wash sale.

As a result, the $200 loss is disallowed as a deduction on your current-year tax return and added to the cost basis of the repurchased stock. That bumps the cost basis of your $600 of replacement stock up to $800, so if you later sell that stock for $1,000, your taxable gains will be $200 instead of $400. And because you previously held XYZ for a year, it will automatically be treated as a long-term capital gain, even if you sell it after just a few months.

So, it's not all bad news. A higher cost basis decreases the size of any future gains realized from the sale of the replacement security, thereby lowering your future tax obligation. If you sell the investment at a loss, the higher cost basis would actually increase the size of the loss for which you could claim a deduction.

And a potential upside of the extended holding period is that it would lower your tax obligation if you sold the replacement security after less than a year. (Normally, short-term capital gains from investments held for less than a year are taxed at the higher regular income tax rate, while longer-term capital gains are taxed at the lower capital gains rate).

Q: What securities are covered by the wash sale rule?

That and several other questions and more are answered in the source here:

https://www.schwab.com/learn/story/primer-on-wash-sales?cmp=em-XCU

[RV_]

What is Tax-Gain Harvesting?

Conversely - Strategically selling your winning investments could reduce current and future taxes.

Excerpt:

"If you have winners in your portfolio, conventional wisdom says to delay collecting your capital gains as long as possible. Doing so allows you to defer paying capital gains taxes—plus, waiting could reduce the amount of tax you ultimately owe if you find yourself in a lower bracket when you do sell.

However, conventional wisdom can sometimes be wrong. By selling some of your winners—a strategy known as tax-gain harvesting—you could actually help reduce future taxes and create a more balanced portfolio.

How does tax-gain harvesting work?

Tax-gain harvesting offers investors the opportunity to realize long-term capital gains with little or no impact to their taxes. Here are three situations in which tax-gain harvesting may be an applicable strategy.

1. You fall into a lower tax bracket this year

If your pay fluctuates from year to year—which may be the case if you're self-employed, on sabbatical, or work part-time—a lean year could provide an opportunity to realize tax-free long-term gains. Individuals who have taxable income of less than $41,675 ($83,350 for married couples) in 2022 fall into the 0% long-term capital gains tax bracket (LTCG).

In this situation, you would look to realize just enough long-term capital gains to stay within the 0% tax bracket. For example, if you're married and your combined taxable income for 2022 is $75,100—wages of $101,000 less the $25,900 standard deduction—you could realize up to $8,250 in long-term gains at the 0% rate. Note that this applies only to long-term capital gains; short-term gains on assets held one year or less are taxed as ordinary income.

 

 

Two more scenarios and details are covered in the article:

2. You want to offset losses

3. You're looking to reduce concentrated positions

Other considerations for tax-gain harvesting

The full short article with charts is here:

https://www.schwab.com/learn/story/how-to-save-money-with-tax-gain-harvesting?cmp=em-XCU

Edited October 18, 2022 by RV_