Tax-loss selling involves an investor selling an asset with a capital loss in order to lower or eliminate the capital gain realized by other investments. This is done for tax purposes since it allows the investor to avoid paying capital gains tax on recently sold or appreciated assets.
Tax Loss Selling
A capital loss is tax-deductible so the loss can be used to offset any capital gains. This helps to reduce an investor’s tax liability. For example, if an investor has a $20,000 capital gain for the sale of a stock, they will fall into the highest tax bracket. This means the investor must pay a 20% capital gains tax ($4,000) to the government.
But, if they sell a different stock for a loss of $8,000, the net capital gain for tax purposes will be $20,000 – $8,000 = $12,000. Therefore, the investor would only be responsible for paying $2,400 in capital gains tax.
[Related: Tax Changes for 2022]
The tax-deductibility of losses may prompt investors to sell at a loss, deduct the loss, and then turn around and buy the same stock again. This is done in an effort to evade taxes, also known as a wash sale. It’s important to note that when participating in tax-loss selling, the IRS prohibits the investor from executing a wash sale.
Tax-loss selling is a good strategy for investors since it allows them to maintain their position while incurring a capital loss. However, wash sales are illegal. Tax-loss selling typically involves investments with large losses, which means the sales normally focus on a relatively small number of securities in the public market. But, if a large number of sellers execute a sell order at the same time, the price of the securities falls.
After the selling season ends, shares that are oversold have a chance to bounce back. Since tax-loss selling often occurs in November and December, the most attractive securities for tax selling are investments that are likely to generate strong gains early in the next year.
Financial Advisor for Tax Loss Selling
It’s important to speak to a financial advisor if you are considered tax-loss selling. While it is a great strategy to reduce your capital gains tax, it must be done correctly. To learn more, contact Argent Bridge Advisors today.