Q. I see a lot of people saying not to sell out of stocks now but also a lot saying selling is good for tax purposes. I can’t simultaneously sell and not sell so how do I determine which is better? — Diane in IHB
A. Diane, financial matters are full of contradictions and tradeoffs. Selling goes against the premise of “buy and hold” but selling for a tax benefit has appeal. I’ll start with the taxes.
Whenever markets drop, the topic of “tax-loss harvesting” comes up. There is no tax benefit to selling for a loss in retirement accounts like a 401(k), IRA or Roth IRA or other tax-deferred accounts. This only applies to non-retirement, aka “taxable,” accounts. Even if you have a taxable account, you must determine if harvesting a loss is likely to be of value to you.
Say you bought shares of XYZ for $50,000 and XYZ is now worth $40,000. By selling the shares for $40,000, you “harvest” a $10,000 loss. Tax law states that the loss is first used to offset capital gains. So, if you also had gains of say $15,000 during the year, your net gain is $5,000 ($15,000 gain less the $10,000 loss). The loss cuts the size of the taxable gain down.
That doesn’t mean you saved any taxes. In some cases, there are no taxes on long-term (held more than 12 months) capital gains. If you are single and your taxable income (gross income less deductions), excluding the gain, is $33,350 or less, the $15,000 gain would not be taxed. The loss you harvested therefore offset a non-taxable gain and was useless. Married filers would have the same situation if their taxable income, excluding the gain, were $81,700 or less.
If losses exceed gains, there may be a benefit to harvesting the loss. If we change the scenario above to one in which there were no gains for the loss to offset, we can use the $10,000 loss to offset up to $3,000 of ordinary income and the remaining $7,000 of loss carries forward into the next year.
That carry forward loss is first used to offset gains that next year. If the entire $7,000 is not used to offset gains, then the remaining loss can offset up to $3,000 of ordinary income. If that doesn’t use up the $7,000, whatever is not used carries forward into the following tax year. The value of the $3,000 ordinary income offset from the loss is based upon the marginal tax bracket.
From an investment perspective, the reason so many people caution against selling is that historically, diversified investors with a longer-term perspective who have the discipline and patience to stay invested until the market recovers have done much better than most of those that try to sell to avoid a further decline. If you would benefit from loss harvesting and want to stay invested, you can sell for a loss yet not sell out of the market.
For example, after selling XYZ for the $10,000 loss, you could immediately use the $40,000 proceeds to buy a security with similar characteristics, say ZYX. If ZYX is similar but not “substantially identical” to XYZ, you get your loss, but you do not alter the fundamental positioning of your investments.
Regardless of the tax benefit of a harvested loss, frequently overlooked is that loss harvesting can increase future gains. When people use the proceeds from a sale to buy other holdings, they may reset the cost-basis lower. In our example ZYX has a basis of $40,000. If its price rises to $50,000 and ZYX is sold, a $10,000 gain will occur. Whereas, if we did not harvest the loss in XYZ, after the recovery, we could sell it for $50,000 and pay no tax because the basis in XYZ was $50,000.
Tax-loss harvesting is often presented as a short-term tactical decision but really it should be considered as part of a long-term strategic plan. Most people have several holdings, multiple tax lots, and multiple possible tax rates throughout their lives. This presents both multiple planning opportunities and pitfalls.
Dan Moisand, CFP, has been featured as one of America’s top independent fee-only financial planners by at least 10 financial planning publications and practices at one of America’s most decorated independent firms. For more info, e-mail him dan@moisandfitzgerald.com, visit moisandfitzgerald.com or call Dan at 321-253-5400, ext. 101.
This article originally appeared on Florida Today: Taking stock of my financial matters: Is it time to sell? Or not sell? | Dan Moisand
Reporting by Dan Moisand / Florida Today
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