Why you’ll want to know your taxable earnings earlier than tax-loss harvesting

There are few shiny spots for traders in a down market. However tax-loss harvesting, which lets you offset earnings with losses, could supply a silver lining. Earlier than trying, nonetheless, you’ll want to know your full tax state of affairs, specialists say.

This is why: There is a lesser-known 0% long-term capital good points tax bracket, that means it is doable you will not owe taxes on all or a part of your funding good points even with out loss harvesting.

And the earnings thresholds are “truly fairly excessive,” mentioned Andy Pratt, companion and director of funding technique at Burney Firm in Reston, Virginia, which ranked No. 9 on CNBC’s 2022 FA 100 checklist.

For 2022, you might fall into the 0% long-term capital good points charge with taxable earnings of $41,675 or much less for single filers and $83,350 or much less for married {couples} submitting collectively.

You calculate “taxable earnings” by subtracting the higher of the usual or itemized deductions out of your adjusted gross earnings, that are your earnings minus so-called “above-the-line” deductions.

With the S&P 500 down greater than 20% in 2022, there could also be ample alternatives to unload shedding belongings.

And if realized funding losses exceed realized earnings, you’ll be able to subtract as much as $3,000 in losses from common earnings per 12 months, with the flexibility to hold losses above $3,000 ahead to offset earnings in future years. 

“In a foul 12 months like this, there’s nothing fairly as good as having the federal government share a few of your ache,” mentioned Dale Brown, board chair at Salem Funding Counselors in Winston-Salem, North Carolina, which ranked sixth on the FA 100 checklist.

However harvesting losses within the 0% bracket will not repay since funding good points aren’t taxable. Sometimes, it is higher to avoid wasting the technique for when earnings exceed the 0% taxable earnings threshold. In any other case, “you’ve got wasted a loss,” Brown mentioned.  

“After we’re doing tax loss harvesting, you are not removing taxes,” Pratt defined. “You are actually simply deferring taxes into the long run,” which can be extra expensive in higher-earning years.

One more reason to not waste funding losses is there could also be limits on how a lot you’ll be able to carry ahead to future years, relying on the place you reside and your age, specialists say.

Whereas it is doable to hold losses ahead for federal taxes, you will not have the identical alternative on each state return, limiting your means to offset future good points, mentioned John Dahlin, director of tax at IFA Taxes, a division of Index Fund Advisors in Irvine, California, which ranked No. 66 on the FA 100 checklist.

And relying on the dimensions of your losses, older traders want to contemplate their life expectancy, Pratt mentioned. “That potential tax profit will simply vanish when the investor passes away,” he mentioned.