2 Ways To Turn Stock Market Losses Into Tax Savings

July 2022 ISSUE July 1, 2022
Tax Individual
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With interest rates rising, inflation surging, and the stock market declining, consumer confidence has recently dropped to a 9-year low. While no one enjoys stock market losses, there’s a silver lining. Tax losses in personal accounts are actually a potential asset that can help lessen the sting of the stock market downturn, but you must take action to realize them.

Tax Loss Harvesting

Selling stocks, bonds, mutual funds, or other personally owned assets (including real estate) that have declined in value allows you to book a capital loss, typically measured by the difference between the selling price and your original purchase price increased by any reinvested dividends. These losses can then be used to offset capital gains, either this year, or in the future.

No capital gains? You can still deduct up to $3,000 in losses a year against your ordinary income, including salaries, rents, or practice profits. Unused losses above that amount can be carried forward indefinitely to offset future gains, such as from the future sale of your practice, office building, other real estate, stocks and/or bonds.

We’re not recommending that you sell out of the market and go to cash and realize ALL of your losses. Rather, we recommend systematically selling losing investments, booking the losses for use against future gains, while staying invested in the market. This strategy is known as tax loss harvesting, and studies show that it can add .50%-1.50% a year to your total investment returns, if done properly.

However, you must avoid the “wash sale” rules when reinvesting to get the best results. To prevent investors from gaming the system, the tax law postpones the use of the losses if you purchase a “substantially identical” security within 30 days before or after the day you sell the loser. So, you can’t repurchase the same stock or mutual fund within 30 days and still claim the loss now. Nor can you sell the same stock in your personal account and repurchase it in your IRA account within 30 days.

If you don’t want to wait more than 30 days to reinvest, you can purchase a similar, but not identical, stock immediately and still claim the loss. For example, you can sell Exxon stock and immediately buy Chevron, another energy company stock, and claim the loss. Likewise, you could sell Facebook and buy Microsoft, another technology stock, or even a technology index fund, and still claim the loss.

Consider A Roth IRA Conversion

Undoubtedly, Roth IRAs are the best retirement account around. While contributions to Roth IRAs are non-deductible, the earnings grow tax-free, and can be withdrawn tax-free after age 59 ½, if the account has been open for at least five years. Moreover, Roth IRA owners aren’t required to take withdrawals over their lifetime, so the assets can continue to accumulate tax-free. Conversely, withdrawals from a traditional IRAs must begin at age 72 and typically rise over time, to accomplish the IRS goal of depleting the account over your lifetime.

Our goal for clients is to have $1,000,000 in their Roth IRA by age 70. That may sound impossible, given that annual IRA contributions are limited to no more than $6,000 per spouse, or $7,000 per spouse if 50 or older. Moreover, some doctors don’t have Roth IRAs because they believe their income is too high to qualify. While there are income limits on direct contributions to Roth IRAs (your Modified Adjusted Gross Income (MAGI) must be less than $129,000 if single, or $204,000 if married), you can still qualify for a “backdoor” Roth IRA contribution. Under this approach, you first contribute to a regular nondeductible IRA (available to everyone regardless of your income level) and immediately thereafter convert by moving the funds out of the regular IRA into the Roth IRA account.

You can dramatically increase your Roth IRA balances by converting more of your traditional IRA funds into your Roth IRA by moving assets from one account to the other and paying income tax on the taxable amount (total transfer less amount of after-tax contributions). So, the best time to convert is when your taxable income is lower (typically in retirement) or when your IRA value has decreased due to a stock market downturn. Converting more when the stock market is down protects more income from Uncle Sam (taxes), provided the market later recovers and grows. 

So, talk with your advisor about making a Roth IRA conversion while the stock market is down. You’ll need to “run the numbers” to determine if paying some tax on the conversion now is a worthwhile investment to avoid much higher taxes in the future.

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