When they rebalance their portfolios, a lot of investors try to lock in their equity gains. These tips may help you limit the tax consequences.
DURING YOUR ANNUAL REVIEW OF YOUR PORTFOLIO, you might think about selling certain investments that have appreciated considerably in value since you purchased them. You can capture long-term gains by selling high performers when you periodically rebalance your portfolio. According to Joe Curtin, head of CIO Portfolio Management, Chief Investment Office, Merrill and Bank of America Private Bank, you might owe capital gains tax on their increased value. Yet, rebalancing can assist you in maintaining your investments in accordance with your objectives and desired asset allocation. And keep in mind that profitable investing results in capital gains taxes, he says.
Although few people enjoy paying taxes, a capital gains tax of, say, 2020%1%20 (rates vary depending on your income)%20%C3%A2%C2%80%C2%94%20and there might be proposals in the future to increase the capital gains tax rate)%20%C3%A2%C2%80%C2%9C may be a small price to pay for success,%C3%A2%C2%80%C2%9D%20Curtin notes âYou can celebrate keeping the 80%. Curtin suggests that there are a few strategies you could talk about with your tax advisor in order to minimize the amount of capital gains tax you might owe. Â He offers several strategies to consider below.
Selling stocks for a gain and then buying them back is a common strategy used by investors to manage their capital gains taxes. However, investors need to be aware of the “wash sale rule,” which can prevent them from claiming a capital loss on the sale of a stock if they repurchase the same or a substantially similar stock within a short period.
Understanding the Wash Sale Rule
The wash sale rule is a provision in the Internal Revenue Code that prevents investors from claiming a capital loss on the sale of a stock if they repurchase the same or a substantially similar stock within 30 days before or after the sale, This rule is designed to prevent investors from artificially generating capital losses to offset other capital gains
Example of a Wash Sale
For example if an investor sells 100 shares of ABC stock for $10 per share on January 15th resulting in a capital loss of $1,000, and then repurchases 100 shares of ABC stock on February 1st, they would not be able to claim the $1,000 capital loss on their tax return. This is because the repurchase of the stock within 30 days of the sale constitutes a wash sale.
Exceptions to the Wash Sale Rule
There are a few exceptions to the wash sale rule, including:
- Gifts of stock: If you gift stock to a charity or another individual, the wash sale rule does not apply.
- Inheritance of stock: If you inherit stock from a deceased individual, the wash sale rule does not apply.
- Covered call options: If you sell a covered call option on a stock and then buy the stock back within 30 days, the wash sale rule does not apply.
Strategies to Avoid Wash Sales
To avoid wash sales, investors can consider the following strategies:
- Wait 31 days to repurchase the stock: The simplest way to avoid a wash sale is to wait at least 31 days after selling a stock before repurchasing it.
- Sell a different stock: If you need to sell a stock to generate a capital loss, consider selling a different stock that is not substantially similar to the stock you want to repurchase.
- Use a donor-advised fund: If you want to donate stock to charity, consider using a donor-advised fund. This will allow you to claim a charitable deduction for the fair market value of the stock without triggering a wash sale.
The wash sale rule is an important consideration for investors who are selling stocks for a gain and then buying them back. By understanding the rule and the strategies to avoid wash sales, investors can minimize their tax liability and maximize their investment returns.
Additional Considerations
- Consult with a tax advisor: It is always advisable to consult with a tax advisor to discuss your specific situation and ensure that you are complying with the wash sale rule.
- Stay informed about changes to the tax code: The wash sale rule and other tax provisions may change over time, so it is important to stay informed about any updates.
Frequently Asked Questions (FAQs)
Q: What is a substantially similar stock?
A: A substantially similar stock is a stock that is traded on the same exchange as the stock that was sold and has similar characteristics, such as the same industry or sector.
Q: What happens if I accidentally trigger a wash sale?
A: If you accidentally trigger a wash sale, you will not be able to claim the capital loss on your tax return. However, the disallowed loss can be carried forward to future tax years.
Q: Can I claim a capital loss on a wash sale if I sell the stock at a higher price later?
A: No, you cannot claim a capital loss on a wash sale, even if you sell the stock at a higher price later. The disallowed loss is permanently lost.
Q: What are some other ways to reduce my capital gains taxes?
A: There are a number of ways to reduce your capital gains taxes, such as investing in tax-advantaged accounts, holding investments for more than one year, and claiming the capital gains exclusion for home sales.
Disclaimer: I am an AI chatbot and cannot provide financial advice. The information provided above is for general knowledge and informational purposes only, and does not constitute professional financial advice. It is essential to consult with a qualified financial advisor for any financial decisions.
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Taking capital gains in different yearsÂ
Spreading the sale over multiple tax years is another option to discuss with your tax professional. This can help reduce the burden, according to Bank of America investment strategist Jonathan McLaughlin.
For instance, you could sell a portion of a well-performing investment at the end of 2023, a portion during 2024, and the remaining portion at the start of 2025. This would allow you to complete the sale in just over a year and spread out any potential capital gains over three tax years, according to McLaughlin.
But donât forget that waiting to sell involves risks. McLaughlin points out that even though selling now would result in a higher tax bill now, there may be benefits to selling now that would outweigh the drawbacks of holding onto those assets.