“But Mike, you’ve told me for years not to sell when the market is down.” And I still stand by that. However, there are times and circumstances when selling something for a loss makes sense.
First, we are talking about non-qualified accounts, which are funded with after-tax dollars. You don’t recognize losses or gains in qualified accounts, so selling something at a loss does nothing for you tax-wise.
The other thing to realize is that we are not getting out of the market, but instead, adjusting our holdings to rid ourselves of something we don’t want in favor of something we do. Let’s assume that we own $100 shares of XYZ stock that we bought at $10 a share. The market moves down, and it is selling for $7 a share. By selling XYZ stock, we would generate a loss of $3 per share or $300.
The IRS says that we cannot buy XYZ back or a substantially identical stock back within 30 days of the sell. If we do, we cannot take the loss on our taxes. The IRS doesn’t define “substantially identical stock,” so I think we need to be careful of this gray area. But going from a tech stock into a bond wouldn’t raise any eyebrows at the IRS. I would even argue that going from Amazon to McDonalds wouldn’t be considered substantially identical for this purpose.
The losses that are generated can be used to offset other capital gains that might have been generated from other sells or capital gains distributions paid out by mutual funds. Then any remaining losses can be used to offset ordinary income up to $3,000. Any unused losses can be carried over into future tax years until they are exhausted.
When you sell a security that is below the price you paid for it, it turns a paper loss into a real loss. You can recover some of that loss through tax savings if the loss is generated in a non-qualified account, but you will not recover all of it in tax savings.
So, the purpose of harvesting tax losses is two-fold. Selling a security that is down in price to generate the loss and hopefully buying back the same security or a substantially identical security 30 days later at a price lower than what you sold at; or to sell a security that you don’t want for a loss and reinvesting the funds in an investment that is not substantially identical.
Bear markets like what we are in now are a great time to explore this strategy and see if tax loss harvesting makes any sense for your situation.
These are the opinions of Legacy Wealth Management, LLC and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Mike Berry is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.
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