TAX LOSS HARVESTING AND CARRYOVER RULES

Did you sell an asset or investment in the current year? Do you know how much, if any, will be subject to capital gain taxes? The taxation of capital gains and losses depends on various factors, including holding period, type of asset sold, and other income reported on your return.

Understanding how capital gains or losses are taxed, what is a wash sale, the limits on losses, how crypto is taxed, unrealized vs realized, and the carryover rules are important when you frequently buy and sell assets. 

How are Gains and Losses Taxed?

Tax gains and losses are calculated by taking the sales price minus the basis of the investment. Your basis is generally what you paid for the asset, but it can get more convoluted depending on the type of asset you are selling. For example, your basis in an investment house will include agent commissions, any work done to the property, and the initial purchase price. On the contrary, your basis in stock is generally just the purchase price.

When the sales price exceeds your basis, you have a gain, but when the sales price is less than your basis, you have a loss. There are two types of gains and losses: short-term and long-term. Short-term gains and losses occur when you purchase and sell the asset within a 12-month period. If you hold the asset for over 12 months, you have a long-term gain or loss.

Short-term gains and losses are taxed at ordinary income tax rates, while the tax rate of long-term gains and losses varies between 0% and 28%. The long-term rate you are taxed at varies based on your taxable income and filing status.

What is the Difference Between Realized and Unrealized Gains and Losses?

There is a difference between realized and unrealized capital gains and losses. A realized gain or loss occurs when a sale has actually been made in the tax year. On the contrary, an unrealized gain or loss is an increase or decrease in the value of an asset that has not occurred.

An example of a realized gain would be selling a stock above the price you paid, while an example of an unrealized gain is an increase in the market value of a stock that you haven’t sold yet. Portfolio increases and decreases are not taxable until the sale occurs. Only realized gains and losses are reported on the tax return.

What is a Wash Sale?

A wash sale occurs when you buy and sell the same security within 30 days. When these transactions happen, the loss is disallowed. For example, let’s say you purchased 100 shares of ABC last year for $10 per share. One year later, ABC is trading at $7 per share, so you sell all of your shares for a $300 loss. ABC’s stock drops and hits $4, so you decide it’s a good time to purchase more shares. The $300 loss is disallowed as a current-year deduction.

What are the Limits on Tax Losses?

The IRS does not limit the taxes on gains, but they do limit the amount of losses you can claim. Single taxpayers are limited to a $1,500 loss deduction, while married-filing-joint taxpayers can claim $3,000. This is why many taxpayers implement tax loss harvesting to leverage the $3,000 deduction from ordinary income.

Tax loss harvesting is the process of using the losses from underperforming investments to offset gains from other sales. Effective tax loss harvesting takes detailed knowledge of the investments you currently hold and the potential amount of gain or loss.

Let’s say you have a large gain in the current year from selling shares you had in a startup that took off. Instead of picking up the entire amount as capital gain income, you can look at your portfolio to see which investments are underperforming and aren’t expected to rebound. Selling those shares for a loss will help offset your capital gain income.

However, some tax losses aren’t limited. Losses from passive activities are generally disallowed from being deducted from taxable income unless there was a 100% disposition of the activity. For example, let’s say you were a passive investor in a company that generated $10,000 in losses over the past few years. You decide to sell your ownership percentage. In the year you dispose of the shares, you can take the entire amount as a loss.

What About Crypto Gains and Losses?

Many individuals are purchasing crypto as a way to diversify their portfolios. Since crypto is a digital asset, taxation regulations aren’t fully worked out. Nevertheless, crypto gains and losses do follow the standard short-term and long-term rules and are taxed the same as other assets. Determining the cost basis and holding period can be tricky.

Crypto and other digital assets are now being received in exchange for services. If crypto is received instead of money for services performed, you may be assessed self-employment taxes in addition to ordinary income tax rates.

What are the Carryover Rules?

Capital gains cannot be carried over to future years but instead are recognized in the period that they occur. However, capital losses are carried forward indefinitely. Capital loss carryforwards will need to be broken out by short-term and long-term. In future years that you have capital gains, you can use the capital losses to offset the income and generate a subtraction of up to $3,000. The carryover amounts often differ between federal and state, making it important to keep track of any carryovers.

Summary

Understanding the taxation of capital gains and losses can feel overwhelming, especially with the abundance of different rules and regulations that taxpayers must follow. To ensure you are reporting the correct amount of capital gains and losses and fully utilizing any carryovers, reach out to the team at BUSINESS.

At BUSINESS, we have the knowledge and experience to help you engage in tax harvesting to lower your capital gain taxes. Reach out today to learn more.

Sources

Adams, Hayden. “Watch Out for Wash Sales.” Charles Schwab, 14 Oct 2022, https://www.schwab.com/learn/story/primer-on-wash-sales. Accessed 23 Dec 2022. 

IRS. “Topic No. 409 Capital Gains and Losses.” IRS, 25 Nov 2022, https://www.irs.gov/taxtopics/tc409. Accessed 23 Dec 2022.