With two-and-a-half months to go until the end of the year, it’s not too early for investors to think about underperforming assets in a declining market and consider ways to lower their 2022 tax benefits.
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You should watch out for market declines and look for potential investment opportunities, but most people move closer to the end of the year, especially when it comes to strategies like harvesting tax losses.
By offsetting capital gains with a tax loss harvest, investors can sell securities at a loss to offset their tax liability. If losses exceed gains, taxpayers can use up to $3,000 annually to offset their regular income for federal income taxes. Losses in excess of $3,000 can be carried forward annually to offset future gains.
It sounds simple, but all investors should be aware of the pitfalls associated with selling and reinvesting assets associated with tax loss harvesting. Here are three things to avoid when taking tax losses.
1. Don’t let tax loss harvesting rules ruin your investment strategy
Sure, avoiding capital gains taxes is a smart approach, but selling just to incur a tax loss doesn’t cloud your judgment and jeopardize your entire investment strategy. Just because you can reap your tax losses doesn’t mean you have to. Holding an asset that appears to be a long-term winner may take precedence over trading it.
Additionally, as noted by US News & World Report, some stocks and bonds in the investment mix are lucrative “portfolio divers” that can reduce portfolio risk and add returns without relying on individual securities. It may function as a sifier. Selling them could damage your entire portfolio.
2. Don’t forget to plan for reinvestment
Selling shares at a loss for taxes and leaving it for cash is of little help when choosing a yield. Take your time and think about where you should reinvest your money. As Zoe Financial pointed out, “The key component to recovering tax losses is to keep investing in the market.”
Again, selling just for that is worth nothing to your investment collection. Buying useful alternative investments will expand your portfolio and allow you to attack when the market recovers.
3. Don’t trigger wash rules
To discourage investors from selling loss-making securities solely to claim a tax break, the wash rule requires investors 30 days prior to the sale of selected funds or Prevents purchases of substantially identical assets 30 days before or after (note: the wash sale rule applies 30 days before and 30 days after the sale transaction, so it is valid for a 61-day window).
Purchasing substantially identical securities to offset losses is considered a “wash” and is not entitled to loss deductions.
But what constitutes a “substantially identical” asset or security? This vague description is outlined in the IRS’ long publication 550, according to The Balance. In general, the rules apply to investors who:
buy the same investment.
Buy a substantially similar investment.
Enter into a contract to purchase a similar investment.
Acquire a similar strain of IRA or Roth IRA.
This does not mean that investors must reinvest in an entirely different industry. For example, if an investor sells shares in a technology company in order to take a tax loss, but wants to reflect assets in the technology sector in the portfolio, the investor may transfer the loss-bearing shares to a technology index fund or technology exchange. can be replaced by trade funds (EFTs).
Two additional points about wash rules are important to note.
First, as Forbes pointed out, selling an investment due to a loss in a taxable account and buying the same investment within an IRA will not work. IRAs are a separate asset type, but if purchased within 30 days of being sold, a wash rule violation will occur. This applies to both Traditional IRAs and Roth IRAs.
Second, you can’t get around the wash rule within 61 days by letting your spouse buy an investment and at the same time sell the asset at a loss. As noted by MarketWatch, according to Publication 550, this is done regardless of whether you file jointly or separately.
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By focusing on your investment strategy, planning your reinvestments wisely, and not violating IRS wash sale rules, harvesting can be a year-end loss strategy that can lead to tax returns.
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This article originally appeared on GOBankingRates.com: Discussing Year End Investment Losses? Avoid These Costly Mistakes