Tax-Loss Selling
Tax-Loss Selling
Every investor desires that the prices of their stocks go up. This means higher gains from profits realized by every shareholder of the company. It is absurd to think a trader wanting his shares in the company to decrease in value. However, even if an investor made a fortune out of the stocks he bought it does not necessarily mean that he has no loss. One would be extremely lucky to have a portfolio with pure gain. The reality is there are stocks that will eventually lose.
These losing stocks are not at all useless. Believe it or not, it will come in handy, especially when the IRS comes knocking at your door at the end of the year asking for your income tax return. These loses can be used to mitigate or even offset capital gain tax, thereby reducing personal tax liability.
Accordingly, this method is called tax-loss selling or tax-loss harvesting. This is a tax-reduction technique wherein stock losses will be utilized to lower the amount of taxes paid each year. This is done by selling all the stocks that did not gain and even had lower value, and use the loss incurred as liability in relation to the assets.
Although this is an effective way of reducing the amount of taxes paid, it has limitations. These limitations include the so-called Superficial Loss Rule or the Wash Sale. In this rule, an investor will not be credited with the loss incurred due to stocks that lost in the market. This is due to the nature of the stocks involved. In line with this, the IRS does not allow deduction of taxes for loss of substantially identical stocks. It is defined as stocks issued by the same company and bought or sold 30 days before and after tax loss selling.
For example, an investor would like to avail of the advantage of tax-loss selling. His shares are from XYZ Company. To avail of the reduction in the taxes, the investor will then sell his stocks to trigger loss. Accordingly, if the investor bought or sold stocks of XYZ Company before or after he sold the stocks for tax-loss selling strategy, the IRS won’t credit his loss and deduct in the amount of tax due.
On the other hand, if the investor bought or sold stocks of DEF Company 30 days before and after he sold stocks of XYZ Company to trigger loss, then he will be credited reduction in the amount of taxes due to him.
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