This Critical Stock Strategy Can Save You Thousands In Taxes — But You Need To Do It By Dec. 30

With 2022 coming to an end, everyone’s preparing for the upcoming tax season and looking for ways to reduce tax liabilities.

For those invested in stocks and bonds, “tax selling” might be a viable strategy, but like any tax strategy, certain caveats must be taken into account to avoid problems with the IRS.

How Does Tax Selling Work?

Tax selling is an operation performed by investors in order to reduce their tax liability. It works by selling an asset with a capital loss to reduce the overall capital gains yielded by other investments and, as a result, paying less in taxes.

When an asset is sold at a larger adjusted sum than it was purchased, the difference in price is considered by the IRS as a capital gain. These can include a home, personal-use items like household furnishings, as well as stocks and bonds.

The U.S. government taxes capital gains on a sliding scale, depending on a few factors. Most importantly, the individual’s annual income and whether the gain is considered short-term or long-term is key.

Short-term gains happen when the item is bought and sold within a one-year period or less. These will be taxed as ordinary income, which can range from 10% to 37% depending on the individual’s tax bracket.

When an asset is held for over a year and then sold at a higher price, it’s considered a long-term gain. These are taxed at 0%, 15%, or 20% depending on the individual’s income.

If an asset is sold at a lower price than it was purchased, it’ll be considered a capital loss. Capital gains and losses get balanced into a net capital gain, from which taxes are deducted yearly.

As an example, if you’ve bought a stock for $10,000 and sold it for $15,000, your capital gains will be $5,000. Now, if you’ve purchased a separate stock for $10,000, but sold it for $5,000, you’d have a capital loss of $5,000. The result of the two investments would be a net capital gain of $0, thus, you’d be exempt from paying capital gains taxes in that year.

If you’ve bought stocks in 2021, it’s likely that many of those are worth less today than their cost of purchase. While the old adage of “it’s not a loss if you don’t sell” will always stay true, some investors might consider getting rid of certain underperforming stocks in order to get their money re-invested in more bullish securities.

Doing that before the end of the year would permit investors to discount those losses as capital losses and take advantage of an end-of-year tax-selling strategy.

One caveat should be taken into account. While gains from the sale of personal-use items will be considered capital gains and require the payment of taxes, the opposite does not apply. “Losses from the sale of personal-use property, such as your home or car, aren’t tax deductible,” according to the IRS.

Friday, Dec. 30 is the last day that the markets are open in 2022, and for investors, it represents the deadline for tax selling.

This event can cause end-of-year sales that many times impact the price of securities as many investors try to take advantage of end-of-year selling at the same time.

Beware of Wash Selling

The IRS has certain rules in place to prevent investors from taking unfair advantage of deducting capital losses.

A “wash sale” happens when an investor sells an asset in order to deduct it as a capital loss, and repurchases the same asset before or after 30 days.

The operation can be done legally, but it would be illegal to try to deduct it as a capital loss.

Other derivative rules are in place, including ones that prevent a spouse or a company controlled by an individual from doing the same, as well as others that forbid acquiring a contract or an option to buy the same stock.

A way to avoid doing a wash sale while still maintaining a position in a stock that could bounce back, is to not sell the entire position, but only a part of it. That way, a capital loss can be deducted, but you’ll still have exposure to that stock. You can rebuy your full position after the 30-day waiting period.

You can also sell a stock for its capital loss and buy shares of another company that’s expected to perform similarly, or an ETF from the same sector.

Benzinga’s Tax Guides offer a lot of valuable info for personal tax handling.

Shutterstock image.