MAXIMIZE STOCK MARKET RETURNS BY PERFORMING TAX LOSS HARVESTING TO MINIMIZE TAX BURDEN

One way to maximize your returns in the stock market is to perform tax loss harvesting strategies to minimize your tax burden. Essentially, this involves selling some of your losses to offset your gains.

Typically, I fall into the 24% income tax rate category. However, due to my capital gains to date in 2021, about $6000 of my income would fall into the 32% income tax rate category. As such, it makes sense for me to look for stocks that I haven’t sold yet to see if there are any losses I can use to offset this. If I can successfully do this, then this would effectively represent a 32% gain on those assets which would be advantageous for me.

If you are the type of investor who, like me, typically adds to positions over time when they drop in price, then you will want to ensure your standard taxable investment accounts are set up to track your cost basis using “First In First Out” (this is usually the default setting). If you are more of a momentum type investor who typically adds to positions over time when they increase in price, then you will want to ensure your taxable investment accounts are set up to track your cost basis using “Last In First Out.” Note: The tax loss harvesting strategy does not apply to taxable accounts such as traditional IRAs, 401Ks, and such since they are always taxed based on your income bracket at the time any funds are withdrawn. So, this strategy can only be used for taxable investment accounts outside of traditional IRAs, 401Ks, etc.

To effectively use the tax loss harvesting strategy, you must be sure not to invoke the “wash sale” rule which occurs when a security is sold for a loss and, within 30 days before or after this sale, a “substantially identical” stock or security is bought. The reason you want to steer clear of this is because a “wash sale” will provide no tax benefit until after the point in which you exit your position entirely.

Many investment brokers track each of the lots you buy and sell for each of the stock positions you hold. This can be a very handy tool for considering which financial assets to sell to gain the benefits of tax loss harvesting. For example, Fidelity (which is the online broker I use) tracks each of the lots I buy and sell (see Figure 1 below for an example).

Figure 1: Stock Lots Bought and Sold

The first thing to check to ensure you don’t invoke the “wash sale” rule is the most recent date you purchased shares. As you can see in Figure 1, 11/22/2021 was the last time I purchased shares of stock XYZ (and if you have multiple accounts you need to check them all since the “wash sale” rule applies across investment accounts whether taxable accounts or not including Roth accounts). So, to ensure that I don’t invoke the “wash sale” rule I need to wait until 30 days have passed before selling the stock. So, to be safe, I will need to wait until 12/23/2021 before selling this stock.

Since I am trying to offset about $6000 of the gains I’ve had over the past year which would fall into the 32% income tax bracket, I would sell about 400 shares of stock XYZ if Figure 1 represents my losses at that time. Because, my taxable investment account is set up to track my cost basis using the default of “First In First Out” I would start from the bottom of Figure 1 and work my way up from there to reflect what losses I could use to offset my gains. So, starting from the bottom and going up if I sold 400 shares (160+140+100) at that time, then I would have $6092.45 ($5020.74+$625.21+$446.50) of capital losses I could use to offset my capital gains. And if I wanted to be much more precise about the $6000 figure, I could sell a couple of shares less. The other nice thing I can do with this strategy is wait to sell those lots in Figure 1 that I have gains on until after a year has passed. Because then instead of paying 24% tax on those gains, I’ll only have to pay 15%. So, this strategy can allow you to both earn a substantial “return” on your losses and and minimize the taxes on your actual gains.

Now, if you accidentally had your investment account set-up to track cost basis using “Last In First Out” then you would probably have to sell all of your shares to realize the tax benefit you’re seeking. However, the tax loss offset would be much less since you would first be selling all of the shares that had gains or were less negative in nature. So, it’s important to make sure you set up your taxable investment accounts to track cost basis using “First In First Out” unless you tend to be more of a momentum type investor.

For people who do tend to be momentum type investors who typically add to positions over time when they increase in price and have their taxable investment accounts set up to track cost basis using “Last In First Out,” then you would start from the top and move down since the newest shares would be sold first. And you would try to hold your gains until after a year has passed so that you’ll only have to pay long term capital gains taxes (typically 15% or 20% depending on your income tax bracket) instead of the short term capital gains taxes associated with your income tax bracket.

So, the above pretty much sums up how to maximize your investment returns by using tax loss harvesting strategies to minimize your tax burden. The last thing you will want to do, however, is to ensure the “wash sale” rule is not invoked going forward by refraining from buying the same stock(s) within 30 days after selling it for a loss. If you do, then the “wash sale” will be invoked again and you will have realized no tax benefit from selling your losses. So, always be mindful of this.

By using the above strategy, I will avoid having to pay about $1920 on my tax return for 2021 (0.32*$6000 =$1920). So, using this strategy can really help.

You can be a very successful investor if you effectively use all of the tools and techniques available to maximize your investment returns. And tax loss harvesting can be an effective strategy to use.

You can learn about all of my investing techniques via my “Invest Like a Pro in 10 Minutes a Day!” series of 4 books where you can learn the “end to end” process to investing and gain key investing insights and skills (https://brighterdayslifecoaching.com/published-books…/)

Also, you can read all about my stock market activities here: https://brighterdayslifecoaching.com/stock-market-activities/

I wish you much success in creating a brighter financial future for yourself, your loved ones, and those who follow.

Happy investing everyone!

#finance #stocks #investing #stockmarket #success#taxes