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In a declining market, there are few bright spots for investors. But tax losses that allow you to offset gains with losses can offer a silver lining. Before you try, though, you need to know your full tax situation, experts say.
Here’s why: There’s a lesser-known 0% tax bracket for long-term capital gains, which means you might not owe tax on all or part of your investment gains, even if you don’t incur any losses.
And the breakeven points are “actually pretty high,” said Andy Pratt, partner and director of investment strategy at the Burney Company in Reston, Virginia, which is ranked #9 on CNBC’s 2022 FA 100 list.
For 2022, you may fall into the 0% long-term capital gains rate with taxable income of $41,675 or less for single individuals and $83,350 or less for married couples filing together.
You calculate “taxable income” by subtracting the higher of the standard or individual deductions from your adjusted gross income, which is your income less so-called “above-the-line” deductions.
Losses can be “squandered” in the 0% bracket
With the S&P 500 down more than 20% in 2022, there could be ample opportunities to sell loss-making assets.
And when realized investment losses exceed realized gains, you can deduct losses of up to $3,000 per year from regular income, with the ability to carry losses over $3,000 forward to offset gains in future years.
“In a bad year like this, there’s nothing quite like the government sharing some of your pain,” said Dale Brown, chief executive officer at Salem Investment Counselors in Winston-Salem, North Carolina, which ranks sixth on the FA 100 list proven .
But crop losses in the 0% category won’t pay off since investment gains aren’t taxable. As a rule, it is better to save the strategy when the income exceeds the threshold of 0% of the taxable income. Otherwise, “you’ve wasted a loss,” Brown said.
“If we reduce tax losses, taxes will not be abolished,” Pratt explained. “You’re really just deferring taxes into the future,” which can be more expensive in higher-income years.
Carrying forward of investment losses may be limited
Another reason not to squander investment losses is that depending on where you live and your age, there may be limits to how much you can carry forward into future years, experts say.
While it’s possible to carry forward losses for federal taxes, you don’t have the same opportunity with every state return, which limits your ability to offset future gains, said John Dahlin, tax director at IFA Taxes, a division of Index Fund Advisors in Irvine, Calif. which is ranked 66th on the FA 100 list.
And depending on the size of your losses, older investors need to consider their life expectancies, Pratt said. “That potential tax advantage will just disappear when the investor dies,” he said.
https://www.cnbc.com/2022/10/25/why-you-need-to-know-your-taxable-income-before-tax-loss-harvesting.html Why you need to know your taxable income before claiming tax losses