6 Things to Know About Harvesting Capital Losses
When markets experience a significant downturn, it can be challenging to find a “bright spot” in the midst of bad news. However, opportunity for investors still exists even when markets drop.
One such opportunity is the ability to potentially reduce taxes by harvesting capital losses. When an investor sells an asset at a loss, that loss can offset their tax liability for the calendar year in which the asset was sold. However, before selling an asset for a gain or a loss, it’s important to know these six factors that could impact how much your taxes are impacted.
1. Short-term gains and losses are calculated at marginal tax rates on ordinary income.
Short-term gains and losses are those realized on an asset an investor has held for one year or less. These are still taxed at ordinary income rates, based on the investor’s income tax bracket
2020 Income Tax Brackets1
|Rate||Individuals||Married Filing Jointly|
|10%||Up to $9,875||Up to $19,750|
|12%||$9,876 to $40,125||$19,751 to $80,250|
|22%||$40,125 to $85,525||$80,251 to $171,050|
|24%||$85,526 to $163,300||$171,051 to $326,600|
|32%||$163,301 to $207,350||$326,601 to $414,700|
|35%||$207,351 to $518,400||$414,701 to $622,050|
|37%||Over $518,401+||Over $622,051+|
2. Long-term gains are taxed at capital gains rates.
Capital gains rates apply to gains and losses realized on assets held for more than one year. These rates include three brackets: 0%, 15%, and 20%.
2020 Long Term Capital Gains Brackets2
|Long Term Capital Gains Rate||Married Filing Joint||Single|
|0%||$0 – $78,750||$0 – $39,375|
|15%*||$78,751 – $488,850||$39,376+ – $434,550|
|20%**||Over $488,851+||Over $434,551+|
If the investor is subject to the net investment income tax (NIIT) of 3.8%, then the actual long-term capital gains tax rate is 23.8%. This amount applies to modified adjusted gross income (MAGI) exceeding $200,000 for single filers or $250,000 for married filing jointly.3
3. Capital losses offset gains first, then ordinary income.
Losses are used to offset gains first, starting with like-to-like and then like-to-different. For example, short-term losses would offset short-term gains first. Any excess short-term losses would then be applied to long-term losses.
If losses exceed both short-term and long-term gains, taxpayers may then use up to $3,000 a year to reduce ordinary income. If more than $3,000 in losses is still remaining, the excess can be carried forward for the future.4
4. Apply as much capital loss as possible to short-term gains to enhance potential tax savings.
Since short-term gains are taxed at marginal ordinary income rates, taxpayers tend to pay more for short-term gains. As a result, it is more effective and beneficial to offset short-term gains as much as possible.
5. Gains and losses also apply to state taxes.
When calculating your numbers, be sure to include state rates for capital gains, which could impact how much investors pay in State and Local Taxes (SALT)Keep in mind that the Trump Tax Cuts & Jobs Act of 2018 capped the deduction for state and local taxes from federal returns. The SALT deduction caps the deduction for property taxes and state and local income taxes at $10,000.5
6. Gifting appreciated stock can save on capital gains tax.
The 2020 annual exclusion amount for gifts is $15,000 per recipient.6 When you gift an appreciated stock, the recipient takes your low basis but takes advantage of a 0% capital gains rate if they sell it and are in a lower tax bracket.7 The gift can help lower the taxes or even avoid paying them altogether on the gains realized on that asset.
As you’re considering the potential sale of an asset for the purpose of harvesting losses, it’s crucial to also consider how the investor’s overall strategy might be changed. Will the portfolio need to be rebalanced? Does a sale support the investor’s goals and objectives? These are important questions and may be the decided factor in whether or not an asset should be sold.
1 IRS. Feb. 20, 2020. “IRS provides tax inflation adjustments for tax year 2020.” https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020. Accessed March 24, 2020.
2 IRS. Feb. 11, 2020. “Topic No. 409 Capital Gains and Losses.” https://www.irs.gov/taxtopics/tc409. Accessed March 24, 2020.
3 Fidelity. Dec. 4, 2019. “How to cut investment taxes.” https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting. Accessed March 24, 2020.
5 William Perez. The Balance. March 3, 2020. “Claiming the State and Local Income Tax Deduction on Federal Taxes.” https://www.thebalance.com/state-income-tax-deduction-3192840. Accessed March 24, 2020.
6 Ashlea Ebeling. Forbes. Nov. 6, 2019. “IRS Announces Higher Estate and Gift Tax Limits for 2020.” https://www.forbes.com/sites/ashleaebeling/2019/11/06/irs-announces-higher-estate-and-gift-tax-limits-for-2020/#26c8923d2efb. Accessed March 24, 2020.
7 Bruce Brumberg. Forbes. Nov. 5, 2019. “6 Ways to Defer or Pay No Capital Gains Tax On Your Stock Sales.” https://www.forbes.com/sites/brucebrumberg/2019/11/05/tax-strategies-6-ways-to-defer-or-pay-no-capital-gains-tax-on-your-stock-sales/#150b1ce97ae1. Accessed March 24, 2020.
For Investment Professional Use Only
When discussing tax objectives as part of the overall financial plan and portfolio allocation, it must at all times be made clear to the client that neither the firm nor advisor (absent the required licensing and credentials) is providing tax advice and that all decisions regarding taxes should be made in conjunction with the guidance of a qualified tax professional.
The information and opinions contained herein are provided by third parties and have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Advisors Excel. This information is not intended to be used as the sole basis for financial decisions, nor should it be construed as advice designed to meet the particular needs of an individual’s situation.