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How do I use portfolio losses to reduce the tax bill from my gains?

Stock market volatility has been tough on many investors. But, like most things, there is a silver lining to this most ominous of clouds – and it’s called offsetting.

If you are concerned about recent declines in your portfolio due to the market’s movements, never fear. They can create a ray of sunshine come tax time – and your Raymond James financial advisor is just the person to help.

Capital gains

Simply put, capital gains are the amount by which an asset’s selling price exceeds its initial purchase price. Therefore, if you bought 200 shares of ABC stock at $20 per share and later sold them at $40 per share, your capital gain would be $4,000, minus any commission or fees. The IRS would then tax your $4,000 capital gain, regardless of how long you have owned the stock.

However, it’s important to remember that the tax treatment of your gains and losses is generally determined by how long you have held an asset before selling it. Gains and losses from assets held for one year or less are considered short-term and are taxed at ordinary income tax rates. Long-term capital gains tax rates can reach as high as 20%.

Capital losses

Conversely, a capital loss is the result of selling an investment at less than the purchase price. Any expenses from the sale are then deducted from the proceeds and added to the loss. It is important to remember, however, that capital losses are only losses if you sell. A stock sitting in your portfolio with a deflated price may cause you distress, but it doesn’t benefit your taxes.

Offsetting gains

Who said the IRS isn’t friendly? After all, they offer investors a break when the stock market struggles – and that break comes in the form of offsetting.

In order to reduce tax on your capital gains, the IRS allows you to sell declining investments in the same year, thereby reducing your capital gain tax. In fact, the IRS will allow you to apply losses up to $3,000 per tax year. So, if you had a really bad year and ended up with a net loss of more than $3,000, you can carry forward the leftover portion to next year’s taxes. The unused loss can then be applied to next year’s gains, as well as up to $3,000 of earned income. Therefore, it’s important that you keep good records – a big loss can be used as a deduction both now and later. Although, you should keep in mind that you must match long- and short-term gains and losses together. In other words, you cannot offset a long-term loss with a short-term gain.

Although mixing losses with capital gains is a good strategy to reduce your tax bill, it’s not the only way to do so. For more information about offsetting and other tax planning strategies, please contact your Raymond James financial advisor. If you’re already a client, use our Office Locator to find our office(s) nearest you today.