Using Stock Losses to Lower Your Tax Payments

Article in Summary:

  • By selling for a loss, you can offset future gains, up to $3,000 worth of ordinary income each year.
  • This procedure is called Tax Loss Harvesting

The other day a prospect came to my office who was looking for someone to help him manage his nest egg as he prepared for retirement.  He was expecting a windfall after he sold his business of around 1 million dollars. Couple that with his current nest egg of $1.5 million, he was looking forward to a nice income in retirement. But one thing puzzled me: he had $200,000 in 2008 losses in his brokerage account that he hadn’t captured for tax purposes.

I asked him why he hadn’t taken advantage of his losses for tax purposes. He just shrugged. Then I explained that by selling for a loss, he could use these losses to offset future gains, and up to $3,000 worth of ordinary income each year. If he was worried about missing a market recovery, he could invest in a similar investment and remain exposed to any upturn in the market market. He shrugged again.

A couple of weeks later, I called him to see if he had considered what I shared with him. The truth came out. He said that right now, they are only paper losses. If he sold, they’d be actual losses, and it hurt too much to acknowledge that he’d lost $200,000 in the market. If they can make it back to even, he wouldn’t have lost anything.  While psychologically comforting, he would have lower taxes if he captured his losses.

This procedure is called Tax Loss Harvesting. It is when you sell your investments that are below your original investment to capture losses for tax purposes. By selling your losing positions, you recognize losses that you can use in several ways for tax purposes. Let’s explore a few:

  1. Against Current Capital Gains –Any investment gains you have can be offset by captured losses.
  2. Against Future Capital Gains –  Losses in excess of current gains can be carried forward and used against future gains which will probably be at higher capital gain tax rates.
  3. Against up to $3,000 of Ordinary Income – You can offset up to $3,000 of ordinary income with losses you’ve captured. (For example – If you pay 30% in taxes, you’ve just lowered your taxes by $900 each year until you use your losses up. (30% x $3,000 = $900).
  4. Against Small Business Property Capital Gains – Depending on how your business is structured, you might be able to offset gains from the sale of business property on Form 4797. Under Part I, line 9 you enter the gain from line 9 as a long term capital gain on the Schedule D filed with your return.
In the case of the prospective client above that is selling his business, if he had $200,000 in capital gains from the sale of components of that business, he might be able to offset these gains with the losses he captured from his investments. But this depends on the nature of the gains and how his business is structured, i.e. S Corporation or Partnership, etc.
In conclusion, when the market is down, and you don’t want to open your monthly investment statements, you might consider doing a little financial and tax planning and capture those losses.

About the author

Richard T. Feight, CFP®
Richard T. Feight, CFP®

Among independent financial advisors, Mr. Feight is one of the most well known and highly respected “Fee-Only” financial planners. Since 1997, Rich has dedicated his career to offering low cost “Fee-Only” comprehensive financial planning and investment advice. Rich assists his clients in organizing their finances so that they can retire on time.Rich is a graduate of Michigan State University where he received his degree in Finance. Rich has earned the Certificate of Financial Planning from The College for Financial Planning in Denver , Colorado that was comprised of intense graduate level classes grounding him in the various foundations of financial planning. He is a CFP® (Certified Financial Planner®) since 2001, meeting the experience, education requirements and passing the two-day, 10 hour exam, making him one of the few in the country who hold the designation. Since 2003, Rich has subscribed to the stringent and mandatory annual educational hours, experience, and code of ethics to meet the requirements to be a NAPFA Registered Financial Advisor. Out of the 800,000 individuals in the country who claim they are financial advisors/planners, fewer than 1,300 in the country qualify for the membership; Rich is one of them.

Rich is the President of the Financial Planning Association (FPA) of Michigan . The FPA of Michigan is one of largest and influential chapter in the country. Rich was recently named President for Transportation Toastmasters Club 4776 downtown Lansing . He has been quoted in both local and national media from Noise Magazine to CNBC, and Bloomberg, and industry news publications such as Investment News and Financial Advisor Magazine. Rich enjoys public speaking and has spoke at industry educational meeting, high schools, and executive investment clubs, AARP conferences, and business educational seminars for companies looking to educate their employees. Rich views his role as a Fiduciary for his clients as the single biggest key to any planning relationship and strives to provide the most competent, unbiased and objective advice in the financial planning profession today.

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