If you hold investments outside of tax-advantaged retirement plans such as Individual Retirement Accounts and pension plans, you may be able to take steps before year end to reduce your 2016 tax liability.
How to harvest investment losses
Suppose you’ve sold investments at a loss this year but you have other investments in your portfolio that have appreciated. If you believe those appreciated investments have peaked in value, you may want to sell them before this year ends, at least to the extent that the gains from the sales will be offset by your losses.
But what if you’ve sold investments and are fortunate to have gains this year? By the last business day of the year (December 30, 2016), you can sell some losing investments to absorb these gains. This strategy of selling investments as a loss to offset gains generated during the year is commonly referred to as harvesting investment losses.
Tax rates to consider
At the federal level, long-term capital gains (on investments held more than one year) are taxed at federal rates as high as 20%. Plus, if you’re subject to the 3.8% net investment income tax, the actual federal rate can increase to 23.8%. The short-term capital gains rate (on investments held one year or less) is the same as the tax rate you pay on ordinary income, so it can go as high as 39.6%.
The netting rules
Before taking action, you need to keep in mind the netting rules for gains and losses, which depend on whether gains and losses are long-term or short-term.
To determine your net gain or loss for the year, long-term capital losses offset long-term capital gains before they offset short-term capital gains. In the same way, short-term capital losses offset short-term capital gains before they offset long-term capital gains. And you may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing your adjusted gross income. Any remaining net losses are carried forward to future years.
Start planning now
Careful handling of your capital gains and losses can save you substantial amounts of tax. But make sure you fully understand all of the implications for your tax and investment situation. Contact us if you have questions on how to harvest investment losses.