It's harvest season for your portfolio, at least if you are hoping to save on taxes.
December is the time when many people think about harvesting tax losses to cut their tax bills (though it's possible any time of year). Selling stocks or other assets that have lost value generates a reduction in your tax liability that you can use to offset capital gains.
The market's recent ups and downs have been unsettling, but the silver lining is that any losses in your portfolio may make April 15 considerably less unpleasant if you decide these are assets you no longer want to hold.
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"Do I have some security that I just don't fundamentally believe in any more and I want to reduce my allocation or get out? Do I have an asset allocation that is out of balance?" said John Sweeney, executive vice president of retirement and investing strategies at Fidelity. If so, he said, "you can sell both your winner and the security that is underwater."
Selling short-term assets is especially helpful at tax time. Losses on those assets can be used to offset any short-term capital gains, and short-term capital gains are taxed at ordinary income rates, not at the lower long-term capital gains rates.
The higher your tax bracket, the greater the potential for tax-loss harvesting to save you money. Top earners in the 39.6 percent income tax bracket wind up paying a rate of 43.4 percent on short-term capital gains, since taxpayers in that bracket also pay the Medicare surcharge of 3.8 percent.
"Technically, everybody can and should be looking to do this," said Paul Giliberto, senior wealth planner at SunTrust Bank. "[But] higher income taxpayers are the ones that stand to gain the most."
In fact, in the lowest tax brackets, your long-term capital gains rate goes to zero. In that case, harvesting gains makes more sense than harvesting losses. It won't affect what you owe in taxes now, but you will be able to lock in a higher cost basis if you repurchase that asset at the current higher price, reducing your potential future tax liability.
"People at the zero capital gains rate can sell winners and get them back at a higher basis at no cost," said Michael Kitces, partner and director of research at Pinnacle Advisory Group. But for those people, "tax-loss harvesting is a disaster. You step your cost basis down and get no savings."
Long-term tax planning can also help you decide whether to harvest tax losses. If you expect your income to be lower in future years — if you are heading into retirement, or have just coming into a sudden one-time windfall, or you are selling your home and downsizing — it may make sense to harvest losses now when the tax savings are greater.
If you believe overall tax rates are on track to fall, harvesting losses now also makes sense.
"Take the loss at the higher rate if you think the next president will have a policy of lower tax rates," said Bob Meighan, a vice president at TurboTax. "People are all about saving today."