How to harvest capital losses

As the end of the year approaches, it’s worth taking a look at the possibility of harvesting capital losses. Doing so may save taxes and can be a positive in years when the markets don’t provide strong returns.

If you’ve been a client for a long time you know that in the ’90s we probably didn’t look at planning opportunities like tax losses because market gains were so strong. But in the 2000-02 market, and again in 2008, there’s a good chance if you had a taxable account with me that we looked at this process.

What is a capital loss?

Simply put, a capital loss occurs when the value of an investment falls below its cost basis. The simplest example is if you put, let’s say, $10,000 into an investment and its market value falls to $9,000. But, it’s also possible to have an investment gain and a capital loss.

How it works

A “paper loss” alone is not enough to recognize and therefore deduct the loss. The loss must be realized by selling or exchanging the asset. Once that’s done …

  • Realized capital losses are generally first offset against realized capital gains.
  • Any excess losses can be deducted against ordinary income up to $3,000 ($1,500 if married filing separately) on line 13 of Form 1040.
  • Losses in excess of this limit can be carried forward to later years to reduce capital gains or ordinary income until the balance of these losses is used up.

Capital gains and losses on the sale of investments are classified as either short-term – if the property has been held for one year or less – or long-term and are shown on Schedule D of Form 1040. Though these two categories of capital gains and losses are subject to different rates in the event of a net gain, a net capital loss resulting from either category is directly deductible from ordinary income up to the annual limit.

In some instances, it may be important for you to specify the cost basis of the shares of stock that you plan to use to offset any capital gains. To maximize your losses for tax purposes, you’d want sell the shares that have lost the most, in order to offset the most gains. This involves coordination so that the proper shares are designated. Most people, however, will use the average cost basis method and thus do not have to identify specific shares.

A conversation with me, your tax preparer or both of us may be helpful in determining if you have losses and if recognizing them makes sense for you.