Using Stock Market Losses To Lower Taxes

Are you afraid to sell your stocks for a loss? Do you think that if you sell a loser, the losses will be REAL? Don’t let fear create your investment strategy. Using stock market losses can lower your taxes.

The Story

The other day a prospect came to my office who was looking for someone to help him manage his nest egg. He was preparing for retirement and expecting a $1 million windfall after he sold his business. Combined with his current nest egg of $1.5 million, he was looking forward to a nice retirement. But one thing puzzled me: he had $200,000 in losses in his brokerage account that he hadn’t captured for tax purposes.

I asked him why he hadn’t taken advantage of his losses for tax purposes. He just shrugged. Then I explained that by selling for a loss, he could use these losses to offset future gains, and up to $3,000 worth of ordinary income each year. If he was worried about missing a market recovery, I would suggest similar investments so he could remain exposed to an upturn in the market. He shrugged again.

The Truth

A couple of weeks later, I called him to see if he had considered what I shared with him. The truth came out. He said that right now, they are only paper losses. If he sold, they’d be actual losses, and it hurt too much to acknowledge that he’d lost $200,000 in the market. If he can make it back to even, he wouldn’t have lost anything.  While psychologically comforting, he would have lower taxes if he captured his losses.

Tax Loss Harvesting

This procedure is called Tax Loss Harvesting. It is when you sell your investments that are below your original investment to capture losses for tax purposes. By selling your losing positions, you recognize losses that you can use in several ways for tax purposes. Let’s explore a few:

1. Current Capital Gains –Any investment gains you have can be offset by captured losses.
2. Future Capital Gains –  Losses in excess of current gains can be carried forward and used against future gains.
3. Against up to $3,000 of Ordinary Income – You can offset up to $3,000 of ordinary income with losses you’ve captured. If you pay 32% in taxes, you’ve just lowered your taxes by more than $900. This will happen each year until you use your losses up. (30% x $3,000 = $900).
4. Offset Small Business Property Capital Gains – Depending on how your business is structured, you might be able to offset gains from the sale of business property on Form 4797. Under Part I, line 9 you enter the gain from line 9 as a long-term capital gain on the Schedule D filed with your return.

Applying Losses to This Case

Takeaway