If this fall's market turbulence is giving you vertigo, here's a thought that might make you feel a little better: your losses could help you save on 2018 taxes.
Say hello to tax-loss harvesting.
If you have a taxable account, this strategy allows you to sell stocks, bonds and other investments that have fallen in value so that you can offset capital gains from holdings that you've sold that rose in value.
"You might have had a large amount of gains recognized throughout the year," said Brian Wainscoat, a CPA and tax specialist at Personal Capital.
"As the market goes up and down, we can look at those losing positions, dispose of them and offset gains from throughout the year, reducing the overall tax liability," he said.
Here's how this strategy works — and what could happen if it goes wrong.
Seizing losses
Recent market activity has left investors with sources of potential losses, assuming that they've sold a few of their holdings amid the downturn.
You can use these losses — assuming you've taken them by Dec. 31 — to offset gains you've picked up elsewhere in your portfolio, which can help you save on capital gains taxes.
In the event you didn't have any gains this year, you can apply up to $3,000 a year in losses to lower your ordinary income.
To the extent your losses exceed your gains, you can carry that amount forward into next year.
Know your tax load
How much you owe in taxes or the amount you save from selling your losing positions will depend on the length of time you held the investment.
If you sell a security that you've held for less than a year, you record either a short-term gain or a short-term loss.
This is where you might find the greatest opportunity for tax savings because short-term gains are taxed at the same rate as ordinary income: up to a top rate of 37 percent.
If you've held a security for more than a year and you sell it, then you've recognized either a long-term capital gain or a loss. Long-term capital gains are subject to a lower tax rate — a maximum of 20 percent.
Catches
If you're planning on selling one of your losing stocks to take a loss and repurchasing it at a later date, be aware of the so-called wash-sale rule.
The wash-sale rule takes effect when you sell an investment at a loss and then buy a substantially similar investment either 30 days before or after that sale. In this case, the IRS won't allow you to take the loss on your taxes.
Be aware that while you may be selling the losers in your taxable accounts, you can run awry of the wash-sale rule if you buy or sell a similar investment in your 401(k) or IRA as well.
"You'd have to look at all of your accounts to see if you've run afoul of this rule," said Wainscoat.
Further, just because you have losers to sell, that doesn't mean you should. Work with your accountant or your financial planner to ensure that your tax-loss harvesting plan doesn't run counter to your long-term goals.
"Think about it, you really don't want to have losses in your portfolio," said Tim Steffen, CPA and director of advanced planning at Robert W. Baird & Co.
"If you have a portfolio that's nothing but gains, it's a good problem to have," he said.
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