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As stock markets experience fluctuations, investors are increasingly looking at ways to protect their portfolios. However, experts caution that many may overlook a valuable tax planning method called tax-loss harvesting. This strategy involves selling investments that have declined in value from a brokerage account in order to offset gains from other investments, thereby reducing overall tax liability.
In practice, tax-loss harvesting allows investors to utilize capital losses to balance out capital gains accrued from the sale of other assets or distributions from mutual funds and exchange-traded funds (ETFs). Notably, if your total capital losses surpass your gains, you can deduct up to $3,000 from your ordinary income. Any remaining losses can be carried forward to future tax years indefinitely.
“It’s about finding a silver lining on a gloomy day,” remarked certified financial planner Sean Lovison, who leads Purpose Built Financial Services in the Philadelphia area.
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Financial advisors recommend that investors closely consider opportunities for tax-loss harvesting particularly during periods of market unpredictability.
“This isn’t just a seasonal strategy; it can be applied throughout the year,” Lovison emphasized, highlighting the continuous nature of market fluctuations.
Currently, the S&P 500 Index remains down over 15% from its peak earlier in the year. Recently, the index dipped into bear market territory, which is defined as a 20% drop from a record high, primarily due to uncertainties surrounding tariff implications.
Here are some essential points to keep in mind regarding tax-loss harvesting according to financial experts.
Adopt a Precise Strategy
Although tax-loss harvesting might seem straightforward, navigating the current downturn necessitates a meticulous approach, according to CFP Judy Brown from SC&H Group servicing the Washington, D.C. and Baltimore regions.
Given prolonged market gains, investments that are underperforming might stem from more recent acquisitions. Brown has been actively determining specific “tax lots,” which represent records of investment purchases that include dates and prices.
“It’s crucial to have a system in place that allows for quick identification of these lots to capitalize on the tax-loss harvesting opportunities,” Brown advised.
Understand the ‘Wash Sale’ Rule
An attractive aspect of tax-loss harvesting is the ability to sell investments at a loss while simultaneously reinvesting in a similar asset to maintain market exposure, Lovison explained.
However, investors need to be aware of the “wash sale rule,” which prevents tax deductions for losses if a substantially identical asset is repurchased within 30 days before or after the sale, as outlined by the IRS.
While selling individual stocks may be more straightforward, guidelines become less clear when dealing with mutual funds and ETFs. For instance, it’s acceptable to sell a large-cap fund from one family and buy another from a distinct family if their holdings differ somewhat, Lovison noted. Yet, if an investor were to repurchase the exact same index fund, it is likely that it would not align with IRS criteria.
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