By: Bruce J. Legawiec, Osborne Rincon CPAs
All over the news these days are the headlines of significant declines in the stock markets, and as a result, many people have seen a decline in their personal net worth. If you are someone that has experienced a decline in your portfolio value, it may be a good time to review your situation and assess if it makes sense (from a tax planning standpoint) to sell losers and “realize” stock losses for tax purposes.
There are a few key points to keep in mind. Stock losses in your retirement account (IRA, 401K or other qualified retirement accounts) are not allowed as a tax deduction on your personal tax return.
If you sell stock for a loss and buy back that stock (or similar investment) within 30 days of the sale, you cannot take a deduction of the loss. This is called the “wash sale” rule. You must sell the stock to realize a loss. A simple decline in value of your portfolio does not result in tax a loss.
Short-term & Long-term Capital Gains and Losses
There are essentially two classes of capital gains and loss: short-term and long-term. Short-term is a security or other asset held for one year or less before it is sold. To be treated as long-term, an asset must be held more than one year. The benefit of a long-term gain is that the gain is taxed at a lower federal tax rate than ordinary income. However, California does not differentiate – short-term or long-term gains are taxed at the same rate as ordinary income.
On an annual basis when a tax return is filed, capital gains and losses are netted against one another to determine if there is a net gain or net loss. If the netting results in a short-term gain, the gain is taxed at ordinary tax rates. If the netting results in a long-term gain, the gain is taxed at preferred long-term rates. It is entirely possible the result is both a net short-term gain and net long-term gain.
If the result is a net loss (short-term or long-term), the amount that can be used for the current year to offset other income is limited to $3,000. Any loss in excess of $3,000 is not lost, but rather carried forward to future years.
When to Take a Loss
When might it make sense to realize a loss on investments? Assume that you sold stocks early in the year and realized a gain. If you are just sitting on losses and do not sell the stock before the end of the year, the loss is of no tax benefit. So, consideration of selling the stock and “realizing” the loss may be of benefit.
What if you sold real estate (or another asset, perhaps a business) in an earlier year for a gain on an installment basis and are still collecting on the note? Each note collection installment received carries with it a portion that is treated as a taxable capital gain. If you are in this situation, it would make sense to review your portfolio to determine realizing an investment loss to offset the installment gain.
Even though we are only just past mid-year, it is still a good time to consider tax planning. Your investment decisions should be reviewed with your financial advisor and CPA before you take action.
Bruce J. Legawiec, CPA, is a Partner with Osborne Rincon CPAs and has over 30 years of diverse public accounting experience. Osborne Rincon is one of the oldest and most respected full-service accounting firms in the Coachella Valley. To learn more, call (760) 777-9805 or go to www.OsborneRincon.com.