Last week we discussed Required Minimum Distributions, or RMDs, which pertain to tax-deferred retirement accounts. This week we shift to Harvesting Tax Losses, a topic for investors owning non-retirement (taxable) investment accounts. The concept is simple – sell assets that have lost value since their purchase, declare the loss on your tax return, and pay less taxes. Like most tax topics, there is complexity, and taxpayers need to know the rules.
The past decade has been strong in the financial markets, and most investors have entered the year with little or no carried-forward (prior-year) tax-deductible losses. That makes December of 2018 Tax Loss Harvesting a potentially valuable process. In order to understand Tax Loss Harvesting, there are two terms you will need to understand; Realized Gains (and Losses) and Unrealized Gains (and Losses). The difference is simple, but important. Realized Gains and Losses have been incurred through a sale of assets. Unrealized Gains and Losses pertain to assets that are still owned, and exist only on paper. For tax purposes, only Realized Gains actually affect your current-year’s returns (and therefore your tax bill).
Here’s the process we use to identify and harvest tax losses:
- Pull out last year’s tax returns to see if you have any remaining “carried-forward” losses, just to be sure
- Check your taxable investment account statements to see if you have realized gains or losses for the current year
- Check those same taxable accounts online, as the information is contemporaneous, to see if you have unrealized gains or losses
- Compare the numbers to see if there is a way to reduce your capital gains for the year to zero or below using offsetting transactions
Many misconceptions exist about the U.S. Tax Code provisions for claiming capital gains and capital losses. In our Financial Planning practice, we encounter many people who do not understand that any and all capital gains are able to be negated with capital losses, if incurred in the same calendar year. Should losses exceed gains, an additional $3,000 of losses can be deducted from taxable income in the year realized, and the balance is carried forward to subsequent years’ returns until fully used.
Knowing the rules will help reduce your tax bill. Should you need help with tax planning, Van Wie Financial can help, whether on the radio or in the office. Be sure to note that we are tax planners, but do not offer tax advice or prepare tax returns.Van Wie Financial is fee-only. For a reason.