Nonetheless, account values are down, and nobody likes it. The S&P 500 is well below its 50 Day Moving Average (DMA) and 50 DMA and not yet showing signs of bottoming. However, corrections do end, and new market trends develop shortly after.
But how can you make lemonade from a lemon market? One way for taxable accounts is to place trades to harvest taxable losses. You can accomplish this by selling positions with current unrealized losses to immediately book (realize) the capital loss. You can apply losses up to $3000 against ordinary income and 100% of the loss against capital gains earned on any asset. The tax loss is kept on your taxable records indefinitely and can be applied against taxable gains in the future. For positions held less than a year, the capital loss is short term and positions held for more than a year are recorded as long-term. In the future, once you have capital gains from sales, all short-term losses are applied against short-term capital gains and long-term losses against long-term capital gains. Your accountant will record all your capital losses and gains into categories of short and long-term and then net each respective gains and losses against each other to determine your net taxable event. If you have more capital losses than gains, the difference is rolled into the next year.
For those that don’t want to be out of the market, you can sell a particular stock or mutual fund to realize a capital loss and immediately buy a similar stock or fund to maintain a similar investment profile. Harvesting tax losses at market lows immediately reduce your loss by the tax savings of the capital loss. For example, you have a stock that has declined by $10,000 that you sell to realize a short-term capital loss. Based on a tax bracket of 37%, the capital loss is equal to $3700 in tax savings reducing your loss by 37%. If you have no capital gains, you can apply $3000 as a deduction against your ordinary income and roll the balance into the next year. You will never lose the capital loss deduction until you have offset all your tax losses against capital gains.
Beware of Wash Sales! If you sell specific equity and rebuy the same position within 30 days, the capital loss is not realized and transferred into the new position. For example, you own $100,000 of XYZ stock and have a loss of $10,000 and sell it. However, the stock starts to recover faster than you thought it would (murphy’s law, of course), and not wanting to miss out on the rebound, rebuy $100,000 of XYZ stock within 30 days. The $10,000 loss is rolled into the new position, and should it gain $10,000 in value and you sell it, you have a net $0 taxable event as the original capital loss is offset by the capital gain.
Those that don’t want to sit in cash can sell one position and immediately buy a similar position. However, if the trading custodian deems your sell and buy are very similar, then the Wash Sale rule will apply and roll the realized loss into the new position. If you are unsure if the trade will trigger the Wash Sale rule, call your investment advisor or trading desk to determine if the trade is at risk of the Wash Sale rule.
Markets fluctuate, and corrections are part of the cycles of the stock market. Last year we were struggling with making trading decisions to improve client portfolio accounts because almost all positions had capital gains and some very significant gains, such as positions in Apple, Home Depot, Cheesecake Factory, Nvidia, Chipotle, QQQ, SPY, etc. We have been aggressively tax harvesting this quarter every possible loss for our clients with taxable accounts (not retirement plans) to realize tax loss deductions to apply against taxable gains in the future. It’s a terrific strategy to capitalize during a poor market that we are confident will improve and provide new investment opportunities.
NOTE: Tax harvesting can be complicated, and you should seek guidance from your tax advisor. This information is not meant to be comprehensive nor consider tax advice.