Home Posts tagged Tax-loss

Tax-loss Harvesting and Crypto

By Contributor
Features

This Strategy May Help You Navigate ‘Wash-sale’ Rule

By Sean Wandrei

 

It is that time of year when taxpayers are looking for ways to reduce their tax liability. It has been a volatile year for the stock and cryptocurrency markets. There may have been some capital gains generated in the beginning of the year when stocks were sold and the markets were doing better than they are now. Now, as the year has progressed, there may be stocks that you are holding that have declined in value. These stocks are ripe for tax-loss harvesting.

Tax-loss harvesting is a strategy used to recognize capital losses by selling capital assets that have declined in value to offset capital gain already recognized. If you have capital gains from stocks that you have sold during the year, you can offset those gains by selling other stocks that have declined in value to generate a capital loss. The capital losses would offset the capital gains that would reduce the amount of taxes that would be paid on those gains by eliminating them. If you end up with capital losses in excess of capital gains during the year, you can deduct up to $3,000 of the net capital loss in the current year. Any capital loss in excess of $3,000 would be carried forward and used to offset future capital gains.

Sean Wandrei

Sean Wandrei

“Tax-loss harvesting is a strategy used to recognize capital losses by selling capital assets that have declined in value to offset capital gain already recognized.”

There could be an issue with this strategy, as the ‘wash-sale rule’ could limit its effectiveness. The wash-sale rule states that, if you are deducting a loss, you cannot buy a ‘substantially identical’ stock or security for 30 days up to the date of sale and 30 days after. If you do, the capital loss may be disallowed. This could be an issue when you sell a stock that you want to stay in, just to generate a capital loss.

‘Substantially identical’ generally means you cannot sell Tesla stock and reacquire Tesla right before or after the sale. If you are selling your Tesla stock just to generate losses and still want to be in Tesla stock, you need to wait 30 days to reacquire it.

What if you are investing in cryptocurrencies? The two most popular cryptocurrencies are Bitcoin and Ethereum, but there are hundreds more that you could invest in. Cryptocurrency prices can be volatile and widely fluctuate throughout the year. Bitcoin has dropped from a price of $66,000 per coin to $16,000 over the past year. Ethereum has seen similar declines over the year.

There may have been many investors who got into the cryptocurrency game hoping to ride the wave of optimism and are now looking at their portfolio, which shows built-in capital losses on their cryptocurrency investments. In 2014, the IRS declared cryptocurrencies to be a capital asset. As of this writing, cryptocurrencies are not stocks or securities and do not fall under the wash-sale rules. There has been some discussion in Washington, D.C. to expand the wash-sale rules to include cryptocurrencies, but as of now, that has not materialized.

If you believe in the underlying blockchain technology and the cryptocurrency associated with it, you may be a long-term investor and want to hold onto the investment believing that there will be future gains. There is an opportunity to reduce your tax liability by selling cryptocurrency that has decreased in value for a capital loss and then buy the same cryptocurrency immediately after the sale. This would not violate the wash-sale rules since cryptocurrency is not viewed as a stock or security. The capital losses generated by this strategy could be used to offset any capital gains that you may have.

Are there some risks with tax-loss harvesting? Of course there are. There is usually a transaction fee associated with buying and selling cryptocurrencies that some exchanges (such as Coinbase, Kraken, or others) charge. This fee could be as high as 4%. Does the cost of the transaction outweigh the tax savings that could be generated from this strategy? As mentioned previously, there are talks of pulling cryptocurrencies into the wash-sale rule, so this should be monitored if you are thinking about this strategy.

Lastly, while tax-loss harvesting defers your capital gains, it does not eliminate them forever. This is a strategy based on the time value of money where tax savings now can be used to invest in more capital assets that will generate income in the future.

As with any tax article, the famous last words: as always, you should see your tax professional advisor if you have any tax questions or concerns.

 

Sean Wandrei is a senior lecturer in Taxation at the Isenberg School of Management at UMass Amherst; [email protected]

How This Strategy Can Help You Reduce Your Tax Bill

By Contributor
Banking and Financial Services

Tax-loss Harvesting

By Gabe Jacobson

Tax-loss harvesting is the selling of stocks, ETFs, mutual funds, and other securities at a loss with the goal of reducing taxes on other short- and long-term capital gains.

Does It Apply to Me?

Minimizing taxes is an important goal for investors, and tax-loss harvesting is a useful strategy for reducing your total tax bill. If you sell stocks, exchange-traded funds (ETFs), or mutual funds for a gain this year in a taxable, non-retirement, investment account, you may want to utilize tax loss harvesting to reduce potential taxes on any capital gains generated by those sales.

Tax-loss harvesting applies to investments of all sizes, so whether you have $5,000 or $5 million in your portfolio, you can still benefit from tax-loss harvesting.

Full-service financial advisors usually perform tax-loss harvesting as a part of their service and will coordinate with your tax advisor, but robo-advisors are beginning to offer this service for additional fees. These fees may not make sense given your situation, so consult your tax advisor if you are uncertain. Even in a rising stock market, some individual stocks or sectors may decline in price, giving an opportunity for tax-loss harvesting, which can be done at the end of the year but may be more effective during periods of volatility throughout the year.

You may want to consult your tax advisor about tax-loss harvesting if you have a self-service brokerage account. Pay special attention to tax-loss harvesting if you bought and sold securities within the same year because your capital-gains tax will be much higher than if you held the investments for over one year.

How Does It Work?

Tax-loss harvesting is also known as tax-loss selling because it involves selling securities at a loss, generating capital losses. This seems counter-intuitive. After all, most people buy securities hoping that the price per share will increase over time, allowing them to earn capital gains when they sell. These capital gains, like all other sources of income, come with a tax bill attached.

“Tax-loss harvesting works because capital losses are subtracted from capital gains when you file your tax return, so you pay taxes only on the gains in excess of losses.”

Tax-loss harvesting works because capital losses are subtracted from capital gains when you file your tax return, so you pay taxes only on the gains in excess of losses. However, capital gains and losses are grouped into two buckets based on how long the investments were held for.

Capital gains on securities sold more than one year after the purchase date are considered long-term and are taxed at lower rates. In 2020, the long-term capital gains rates range from 0% to 20%, depending on income levels; most people will fall in the 15% range.

However, if securities are sold within a year of the purchase date, the gains are considered short-term and are taxed at the same rate as wages or business income, which in 2020 range from 10% to 37%. These two buckets cannot be mixed, so you cannot reduce your short-term capital gains by long-term capital losses or vice versa.

Sure, it’s nice to mitigate your tax liability, but wouldn’t you lose more money selling your investments for a loss than you save in taxes? Why not just wait for those prices to bounce back and sell for a gain, assuming you expect the investment’s price to eventually recover? The price may recover down the line, but the tax bill associated with any capital gains generated this year cannot be avoided unless a loss is generated in the same year.

The solution is purchasing a similar asset shortly after selling for a loss. This way, you ‘harvest’ the capital loss for tax purposes while making little actual change to your investment portfolio. The IRS instructs that you must wait at least 30 days before purchasing another asset that is “substantially identical” to the asset sold for a loss, but there are enough similar assets available to allow immediate reinvestment in most situations.

An Example to Clarify

Here is a hypothetical example using common investments: the S&P 500 large-company index and Russell 2000 small-company index tracking ETFs (the prices are fictionalized for ease of understanding, but the ETFs are real and can be purchased through most brokerages).

In this example, in your brokerage account, you purchased 10 shares of iShares Core S&P 500 ETF (IVV) on Jan. 1, 2021 for $100 per share, for a $1,000 total investment. On the same date, you also purchased 10 shares of the iShares Russell 2000 ETF (IWM) for $200 per share, or a $2,000 investment. By Nov. 1, 2021 the price of IVV (the large-company index) has doubled to $200 per share, and you decide to sell five of your 10 shares, generating $1,000 in short-term capital gains.

However, you do not want to pay income taxes on an additional $1,000 on top of your regular wages. You notice that the small company index IWM’s price has dropped to $100 per share, so you lost $1,000 on that investment. You do not want to sell at a loss, but then you realize that, if you sell all 10 shares of IWM, you can generate a short-term capital loss of $1,000 which will completely mitigate the short-term gains from your sale of five shares of IVV when you file your income tax return.

You sell all 10 shares of IMW, but you still want to invest in small-company stocks. You immediately purchase $1,000 worth of shares in iShares MSCI small-cap index fund SMLF with the cash received from the sale of IWM. This fund gives you similar exposure to the Russell 2000 small-company index fund (IWM) you just sold without tracking the same index, meaning the IRS will not consider the two funds “substantially identical,” so you can purchase it before the 30 days are up. At this point, you have effectively received $1,000 in capital gains without generating any taxable gains, and you have maintained your portfolio allocations.

Note that, if you had purchased IVV more than a year before you sold it on Nov. 1, 2021, the gain would be classified as long-term, so the short-term loss generated on the sale of IMW would not offset this gain. Speak to your tax advisor regarding capital-loss carry-forwards, as capital losses not used to offset gains in one year can be applied to future tax years.

 

Gabe Jacobson is an associate at the Holyoke-based accounting firm Meyers Brothers Kalicka, P.C.; (413) 536-8510.

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