FINDING UPSIDES IN A DOWN MARKET: Using market losses to offset capital gains – without giving up returns

By Hightower St. Louis on November 30, 2022

When the market is down, stocks are on sale! And, while the time may be right to buy in, you may want to consider how selling some investments could bring tax benefits. With an option called Tax-Loss Harvesting, you could claim losses that offset capital gains and lower your tax burden this year. 

Here’s how Tax-Loss Harvesting works:

1. You sell an investment in a taxable account that has experienced a loss. 
   For example, you bought $5,000 in stock holdings then sold the same for $3,500, resulting in a capital loss of $1,500. 
2. You use that capital loss to offset capital gains on other sales, and lower your tax burden for the year.
   In the same example, the $1,500 loss would offset $1,500 in capital gains on a separate securities transaction, dollar for dollar. So your taxable gains could be fully offset.
3. You replace what you sold with similar (but not too similar) investments to maintain your overall portfolio – and still stand to benefit from any market rebound.

While this tactic can be used throughout the year, timing is good now because markets are down. There are likely more losses available for harvesting. Plus, you likely have greater insight into what capital gains may need to be balanced out for 2022. Keep in mind, capital losses must be taken by December 31 to count toward this tax year.

The Tax-Loss Harvesting process is relatively simple, but there is a catch: the wash-sale rule. In order to prevent investors from gaming the system, the IRS prohibits people from repurchasing an identical security for 30 days before and 30 days after the sale that created the capital loss. This applies to all trades under the investor’s or couple’s social security number(s), so IRA account purchases, the vesting dates for stock bonuses, or even employee stock purchase plans can trigger violations of the wash-sale rule. 

So which investments should you consider selling? Prime candidates are those holdings in concentrated stock positions. In these cases, Tax-Loss Harvesting could allow you to update parts of your portfolio on a tax neutral basis. Take this opportunity to redistribute your holdings and further diversify investments. 

That said, it’s important to remember that losses of one type must be used first to offset gains of the same type. So, if you’ve experienced short-term capital gains, you’ll need to offset them with short-term capital losses. This is generally the best way to use Tax-Loss Harvesting, since tax rates are significantly higher for short-term gains than long-term. 

Once losses in a category exceed gains in that same category, you can use the leftovers to offset other gains or even personal income. The annual limit for income tax deductions due to tax-loss harvesting is $3,000 for single or married filing jointly taxpayers (or $1,500 if you are married and filing separately). But there’s no expiration date on capital losses, so you can carry them over to future tax years. 

Tax-Loss Harvesting isn’t meant to be a cancellation of taxes. It’s a postponement. In the long run, the money you’ll be able to save this year – and reinvest – could help you build more wealth than the amount of any future tax bill. 

Zach Ungerott, CPWA®, CFP®
Senior Wealth Advisor
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Hightower Advisors, LLC is an SEC registered investment adviser. Securities are offered through Hightower Securities, LLC member FINRA and SIPC. Hightower Advisors, LLC or any of its affiliates do not provide tax or legal advice. This material is not intended or written to provide and should not be relied upon or used as a substitute for tax or legal advice. Information contained herein does not consider an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. Clients are urged to consult their tax or legal advisor for related questions.