Harvest Time for Tax Losses

401K, IRA, Stocks

For most of us harvest time conjures thoughts of picking apples and nuts, but if you are an investor, the final month of the year is the time to harvest investment losses to offset capital gains and minimize income taxes. It will take a little effort, but you’ll thank yourself come tax time.

Capital Gains Tax
Capital Gains Tax

A capital gain is the profit made when you sell an investment for more than what you bought it for. If your investments sell for less than you bought them for, then you
are entitled to claim a capital loss. If you have incurred capital gains this year, and you have some losing investments in your portfolio, consider harvesting some of those losses to offset the gains so you won’t owe taxes on the capital gain income. Here’s where to start:

Compute the gains on assets you’ve already sold.  Make a list of your sales of stocks, bonds and real estate during the year, and add expected capital gain dividends on mutual funds.

Offset any losses you have already realized this year. That includes the stock you purchased when it was high and you thought it would go higher, but you finally sold when it dropped well below what you paid for it. Don’t forget loss carryovers from prior years – you can spot carryovers on page 2 of last year’s Schedule D of your personal income tax return.

If the gains exceed the losses, look for unrealized losses to offset those gains.  You may be holding onto a stock that has dropped, hoping it will regain its value. This may be a good time to sell the stock and put that loss to work.

Check your income tax bracket.  Before taking the step to sell a stock that has dropped in value, also see if you can take advantage of lower capital gains rates, which were extended until the end of 2012.  The maximum capital gains rate for most people with long-term capital gains is 15%.  If you have income lower than $34,500 ($69,000 for married filing jointly), capital gains and dividends may be taxed at 0% depending on the type of net capital gain!

Beware of the wash sale rule.  You cannot deduct losses from sales in a wash sale.  A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock, acquire identical stock or securities in a fully taxable trade, acquire an option to buy substantially identical stock, or acquire substantially identical stock for your IRA.

Tip:  If you have a disallowed loss from a wash sale, add the disallowed loss to the cost of the new stock or securities.  The result will increase the cost basis of your new stock and decrease your gain on the sale of the new stock.

Don’t harvest too many losses.  Once you have offset your losses against your gains, excess losses can reduce up to $3,000 of ordinary income from employment or other sources. If your losses are greater than that, the excess can be carried over to the next year.

TurboTax easily guides you through the necessary interview questions and accurately makes the behind the scene calculations for your capital transactions.  You can also use tax calculators to help you plan and work through various tax scenarios.