Our financial goals typically revolve around building wealth and a great deal of this is done through investing. We obviously look to find investments that will increase in value but it is inevitable that some of our investments will will stink like a sweaty gym sock. We will curse these investments and blame them for ruining our perfect portfolio, but alas a bad investment can be a blessing in disguise. The blessing comes directly from our friends at the IRS.
That’s right, the IRS allows us to use investment losses in taxable accounts as a deduction. If you currently only invest in retirement accounts, none of this will pertain to you, but please keep reading as you will eventually have taxable investments I’m sure. Unfortunately the wonderful folks at the IRS are only so helpful. They do limit the amount of losses you can deduct but of course they have no limits on how much you gain. Go figure.
You are currently allowed to deduct up to $3,000 in investment losses each year. Amounts in excess of $3,000 can be carried over into future years which can have a significant benefit. Another benefit is that you do not necessarily need to have capital gains in order to use the losses to offset them. If you have a net loss it can be used to offset your regular income. Now this doesn’t mean if you bought and sold two stocks in your portfolio during the year, and stock A gave you a $2,000 gain and selling stock B gave you a $3,000 loss that you can just use that $3,000 loss to reduce your income. What it means is you have a net loss of $1,000 that can you deduct.
The next benefit is the ability to bank your losses. Unlike many tax deductions, losses don’t have a use it or lose it requirement. If you have losses that exceed $3,000 in that year the additional loss can be carried over to be used in future years! As an example say this year your taxable brokerage account saw $20,000 in losses and $10,000 in gains. This means you have a net loss of $10,000 available to claim, but you can’t use it all this year. You have $3,000 available to you for the current tax year, which can reduce your income and $7,000 to carry forward. Next year the market is great and after selling some investments you have realized a net gain of $5,000. You can take $3,000 of that $7,000 to apply towards your gains leaving you with a net gain of only $2,000 and you still have $4,000 left in the “bank”. You just cut your taxable investment gains in half by banking some of the losses you took last year. What a wonderful thing.
Of course when it comes to taxes, please be sure to check with your accountant or tax advisor. Dealing with capital gains and losses can become complicated over time and while it is a powerful tax tool you want to ensure that you are doing it properly to avoid problems. The information here is simply a general rule of thumb to illustrate the value of losing investments, everyone’s scenario is different. And finally, remember to keep your investment objectives always your first priority. Do not get in the habit of selling an investment simply for tax benefits. Evaluate the performance in line with your investment strategy first and determine if selling would first improve your overall investment picture and then determine what benefits it may have on taxes.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
