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Do you have losses on stocks, bonds or crypto? There’s a silver lining at tax time

No one likes investment losses, but some losses have a silver lining.

The markets have been flooded with red ink this year, so now is a good time to review the loss tax code rules for individual investors. They are especially generous for assets held in taxable accounts, as opposed to those held in tax-sheltered accounts such as IRAs or 401(k) plans.

“Tax losses are a potential asset that can mitigate the impact of market downturns,” says Joel Dickson, tax specialist and global head of advisory methodology for Vanguard Group.

The reason: Investors can sell their losers and recognize a capital loss, usually for the difference between an asset’s purchase price and its sale price. Then they can use those losses to offset taxable capital gains from the winners’ sale, either immediately or in the future.

Such losses can harbor gains from a wide range of assets, so losses from selling a bond fund, for example, can offset taxable capital gains from selling a fund. index, cryptocurrency or real estate.

And if an investor doesn’t have enough taxable capital gains, they can deduct up to $3,000 of losses per year from ordinary income like wages or interest. Unused losses beyond this amount are carried forward indefinitely for future use, although individual investors cannot carry forward losses to offset gains on prior year asset sales.

Here is a simplified example. John bought 200 Apple shares for $15,000 in the spring of 2020. Then he paid $45,000 for bitcoin in the spring of 2021. Both holdings are in taxable accounts and John wants the money.

At recent prices, John’s Apple stock had a capital gain of around $14,000 and his bitcoin had a loss of around $15,000. If he sells the two holdings at these prices, his bitcoin loss can shield his gain from the sale of Apple stock and John won’t owe tax on it. The remaining $1,000 loss can offset other taxable gains or, if none, $1,000 of ordinary income.

That’s not all: many investors routinely use tax code rules to sell losers and bank losses to use against future gains while remaining invested in the market. This strategy is called tax-loss harvesting.

A seasoned reaper is David Grabiner, a mathematician on the advisory board of Bogleheads.org, a collaborative personal finance website. Mr Grabiner says he first posted losses during the market downturn of 2002 and has done so since, usually when his holdings – which are mostly ultra-low fee index funds and exchange-traded funds – fell about 10%.

Mr. Grabiner says his accumulated losses have repeatedly allowed him to sell winners without paying tax. In 2013 he put down a five figure down payment on a house and in 2017 he bought a car. He also protected $3,000 in salary per year. This year he has twice collected losses, he says.

“I appreciate Uncle Sam sharing my losses when I have them,” he says.

What difference can harvesting losses make to an investor’s total returns? Mr. Dickson of Vanguard has researched this question in depth and concluded that while returns for individuals vary widely depending on circumstances, many investors can add between 0.5% and 1.5% per year to total return by earning losses.​

He says the variables affecting the benefit include fees, market volatility, tax rates and, most importantly, the amount of gains that can be offset by losses. The higher the tax rate and the higher the investor’s earnings, the greater the advantage is likely to be.

As with many investing strategies, the devil is in the details, so here’s more to know.

Beware of “wash sale” rules on securities.

To prevent investors from playing the system, the tax code defers the use of losses if an investor buys a “substantially identical” security within 30 days before or after the loser sells.

These transactions are known as wash sales. Deferred use of losses applies to wash sales of stocks, bonds, mutual funds and ETFs, among others. This also applies if the investor sells a loser into a taxable account and then buys it into a retirement plan such as an IRA within 30 days. Grants and exercises of stock options are also considered purchases.

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To maintain their portfolio, many investors want to remain invested in the asset they sold. In this case, Robert Willens, CPA and longtime independent tax analyst, advises switching to a similar but not identical holding to catch any rebounds during the 30-day period.

Since there are no official guidelines, the line between “substantially identical” and “similar” is a matter of judgment. Selling an S&P 500 index fund to one company at a loss and buying an S&P 500 index fund from another wouldn’t pass the test, Willens said. But switching to a total market fund immediately after selling a loss-making S&P 500 index fund should be acceptable.

What if exploitation is a single action like Meta Platforms,

which is down more than 40% this year? The investor should not buy back Meta, so Mr. Willens suggests buying an industry peer or targeted fund in which Meta is a component but not the dominant position.

Be aware of the fictitious sale exception for cryptocurrency

Because cryptocurrencies are not securities, they are not subject to wash sale rules under current law. Congress has considered changing this statute, but has not yet done so.

That means a bullish crypto investor could reap capital losses on a stake to offset current or future capital gains and redeem it immediately, tax experts say.

Be notified when deploying casualties

Willens advises investors to take enough capital losses to shelter $3,000 of income such as interest or wages per year. This income is generally taxed at higher rates than long-term capital gains.

Beyond that, the maximum value of losses generally lies in their use to offset short-term capital gains, which are taxable at ordinary income rates.

Investors making charitable donations should also think twice before selling long-appreciated assets and using losses to offset gains. Donating these assets could be more tax efficient, as in many cases the donor owes no capital gains tax and also receives a charitable deduction.

Monitor investment costs

High transaction or advisory fees can quickly erode the value of the tax-loss crop, so watch out for that.

Consider life expectancy

Loss harvesting is often not appropriate for investors who risk dying with unused tax losses. Under current law, capital losses expire on death and there is no capital gains tax on the appreciation of assets held on death, so there is no need to put those gains sheltered.

Write to Laura Saunders at laura.saunders@wsj.com

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#losses #stocks #bonds #crypto #silver #lining #tax #time

Post expires at 9:49pm on Wednesday June 22nd, 2022

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