Here’s How Stock Losses Can Boost Your Tax Refund
Written by
John Csiszar
Edited by
Cory Dudak
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No one invests with the intention of taking losses. On the contrary, the entire purpose of investing is to grow your money, either through capital gains or income. Even though you may have to pay taxes on those gains, they are always preferable to taking losses.
Of course, there’s also no such thing as a perfect investor. Even professional money managers regularly take losses — it’s just a part of the process. The good news, however, is you can use your inevitable losses as a benefit when tax time rolls around. Here’s how:
Offsetting Gains
If you have taxable capital gains, you can offset some or all of those gains by taking capital losses. This process is sometimes referred to as tax-loss harvesting.
Imagine, for example, you sell Nvidia stock for a $15,000 profit in July. As December rolls around, you realize you have a $15,000 loss in your existing Apple position. You can sell your Apple shares, capture that $15,000 loss, and offset your total gain on Nvidia, resulting in a tax liability of zero.
One thing to be aware of with this strategy is the “wash-sale” provision. In the words of the IRS, “A wash sale is the sale of securities at a loss and the acquisition of same (substantially identical) securities within 30 days of sale date (before or after).” Essentially, you can’t sell Apple at a loss to offset your gain in Nvidia, and then buy Apple back within the 30 days before or after you sold it.
It’s also important to note that you should never sell a stock simply for tax purposes. If you’re a long-term believer in Apple, for example, you shouldn’t sell it just to offset your gain because you can’t buy it back for 30 days. During that time, Apple shares may stage a rally, offsetting any tax benefit you may have generated. Only harvest tax losses in shares you would consider selling anyway, from an investment perspective.
Reducing Taxable Income
If your realized capital losses exceed your capital gains, you can use those excess losses to offset up to $3,000 in ordinary income.
Imagine a scenario in which you have $10,000 in capital gains, $13,000 in capital losses and a $70,000 salary. When you offset your gains with your losses, you’re left with $3,000 in excess losses. You can apply that $3,000 to reduce your taxable salary from $70,000 to $67,000, resulting in additional tax savings — or boosting the size of your refund.
Carrying Forward Losses
If you have more than $3,000 in excess losses, you can carry them forward for use in future years. These carry-forward losses last indefinitely.
Imagine that you have $12,000 in losses in one year, but only $2,000 in gains. After you offset your gains, you have $10,000 in excess losses. You can use $3,000 of those in the current year to reduce your ordinary income, and then carry forward the remaining $7,000 to use in future years.
How Much Could Losses Boost Your Refund?
There’s no limit as to how much harvested tax losses could boost your refund. It all depends on the amount and type of your gains and losses, your tax filing status and your tax bracket.
If you’re in the top 37% tax bracket and your losses are all short-term, for example, offsetting $100,000 in capital gains could result in savings of $37,000. If those gains were all long-term, benefiting from the 20% capital gains tax rate, the savings would be $20,000.
Bear in mind that if you’re in the lower tax brackets, your long-term capital gains tax rate might be 15% or even 0%. According to the IRS, the 0% tax bracket applies to the following income levels and filing statuses:
- $47,025 for single and married filing separately;
- $94,050 for married filing jointly and qualifying surviving spouse; and
- $63,000 for head of household.
In those scenarios, offsetting your capital gains won’t result in any tax benefit because you’ll already owe $0 on your long-term gains.
At those income levels, even your short-term gains might only be taxable at 10% or 12%. However, it still pays to offset those gains, as it could save you a few hundred or a few thousand dollars, depending on the extent of your gains.
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