Portfolio tax strategies

Lesson in Course: Work in progress (beginner, 5min)

We've made money from investing but what can we do about the taxes we owe?

What does this mean to us as investors?

OffsEtting gains with losses

Realized losses can be used to offset gains for the year. A realized loss occurs when we sell a stock at a loss from when we bought it. If we bought 10 shares of CCL (carnival cruise line) in January of 2020 for $50 a share and because of Covid-19 we sold all 10 shares in May for $15 a share, the $350 in short term losses can be used to offset the $600 in short term gains from our AAPL shares. 

Losses like gains can be long-term or short-term depending on if the asset was held for more than a year. Long-term capital losses are used to offset long-term capital gains, and short-term capital losses are used to offset short-term capital gains. 

Excess losses can be carried forward into future years and used to offset $3000 in taxable income every year after all gains are negated. For example, let’s assume we have $7000 in short-term capital losses from 2020 and $1000 in short-term capital gains for the year. After offsetting the gains, we would have $6000 in losses, of which we can lower our taxable income by another $3000. For 2021, we would have $3000 in losses from 2020 to be carried forward to reduce capital gains. If there are no capital gains, the $3000 can be used to reduce taxable income again.

Planning on when to sell

We should plan out investment strategies since taxes eat into our return. For example, if our tax rate for our income is currently in the 24% bracket and we have shares with unrealized gains of $1000 and no losses. 

Selling this year would result in roughly $240 in taxes owed or if we can wait a few months and sell next year, we would qualify for long-term capital gains and only pay $150 in taxes. 

Selling this year would result in a return of $1000 - $240 in taxes or $760(what we take home).

Selling next year would result in a return of $1000 -$150 in taxes or $850(what we take home).

Even if the stock price drops over the next couple of months and our gains become $900. Long-term capital gains at 15% result in $135 in taxes and a take-home of $765, which is still better than if we had sold last year as short-term.

Long-term buy-and-hold investment strategies are much more tax-efficient than short-term selling and should be considered. Even professional day traders have long-term investment accounts.

Understanding end of the year sell-offs

Many professional investors work with their accountants to plan tax-loss harvesting, usually towards the end of the year. They will look at stocks that have losses and are out of favor, e.g. travel and leisure stocks in 2020 due to covid-19, and sell them to offset gains for the year; this is called tax-loss harvesting.

Tap for a tip

When tax-loss harvesting, sell stocks that will take a while to recover. The losses will help offset gains for the year and when the stock recovers, buy your position back in.

The selling from the tax-loss harvesting causes additional downward pressure on the price of the stock, which can create a cheaper buying opportunity or inform option traders of the risks.