We’ve seen quite a bit of volatility recently in the stock market, and that has some investors a little rattled. While long-term investors view these types of downturns complacently, waiting it out for eventual gains over a period of decades, other investors end up selling low and locking in losses.
Other investors view these times as opportunities to unload some of the underperforming stocks they’ve been wishing to rid themselves of for a while. They also lock in losses.
While it’s never fun to log investment losses, the reality is that you do have some choices when it comes to getting a tax deduction for your investment losses. Here are some things to think about:
Offset Income by Claiming Capital Losses
You can use your capital losses to reduce some of your income. Your first step is to “match” your capital losses against your capital gains. If you have extra, you can use up to $3,000 of that each year to offset some of your other income, including earned income.
For example, let’s say you sold some stocks earlier in the year for a gain of $1,000. Now, though, you’ve sold some losing stocks, and your capital losses amount to $4,000. The first thing you do is apply $1,000 of your capital losses to that capital gain, canceling it out. Now you have $3,000 in losses left over. You can take those losses and use them to reduce some of your other income by $3,000. While it’s not a huge benefit, it’s still helpful, and if you are on the edge of a tax bracket, or if you are just on the cusp of an income-based phaseout for a credit or deduction, your income reduction can help you keep your other tax breaks.
Carryover Your Losses
Not only can you get a tax deduction this year, but you might also be eligible for a tax deduction later. Capital losses you can’t use this year can be carried over to future years. Let’s use the example above, but instead, you end up with $6,000 in capital losses. As before, the first $1,000 goes to offset your capital gains. Now, you have $5,000 left. However, you can only apply $3,000 of it to this year’s income, leaving you with $2,000 in realized losses. Save your records, and use those losses to reduce your income next year.
Of course, for some investors, the carryovers can go for years. Big investors with lots of money and large positions might see their carryovers span decades. In fact, there are some big investors still using up losses from the last big financial crash because their losses ran into the tens of thousands of dollars.
For most “regular” folks, though, the current system works reasonably well. Many people with their money in tax-advantaged retirement accounts and investments in index funds and ETFs don’t lock in their losses because they don’t sell during these types of market events.
If you do decide to sell right now, be careful of how you proceed, and consider consulting a professional. It might be tempting to sell when you are afraid of bigger losses down the road. However, remember that the folks who sold in 2009 and locked in their losses regretted it in 2011 after the market had come roaring back.