Got Crushed in the Market? Harvest Losses to Lower Taxes

It’s because of the way mutual funds are structured; if other investors want to sell their shares, the fund often has to sell appreciated holdings to meet those redemptions.

Investors who remain in the fund are then on the hook for any gains the fund makes from selling those shares. If you hold those mutual funds in a taxable account, you could owe tax, even if you reinvest the gains back into the fund.

There were record-level mutual fund capital gains distributions in 2021; 2022 isn’t expected to be quite as bad, but it’s still something fund investors should be thinking about and planning for, says Jim Miller, a certified financial planner in Chapel Hill, North Carolina. Locking in stock losses now can help to offset those unwelcome distributions.

Short- vs. Long-Term Holdings

Remember the difference between short-term and long-term holdings when thinking about what to sell.

The IRS considers short-term to be less than a year, so if you sell an asset within that time frame, you’ll be taxed on any gains at the same rate as ordinary income, with a top rate of 37%. Long-term gains are taxed at a top rate of 20% (plus a 3.8% tax for higher earners).

If you sell a stock to harvest the loss and plan on buying it back after the waiting period, remember the clock will be reset again before it can be considered a long-term gain when you eventually sell.

Cyrpto Matters

Finally, crypto. Those investors can tax-loss harvest just like stock investors.

They have an advantage, though — the wash sale rule doesn’t apply to digital assets, so they’re able to sell and then buy the same coin without waiting. Still, some tax experts warn crypto investors could get burned by the IRS’s economic substance doctrine.

That rule basically says that you can’t do something just for a tax benefit, meaning you’d have to expose yourself to some sort of market risk before buying the same coin, according to Matt Metras, an accountant in Rochester, New York, who represents taxpayers before the IRS.

But whether that’s 10 minutes or 10 days is anyone’s guess. As with stocks, it’s better to err on the side of caution.

It’s been a rocky year in the markets, but smart moves now can make taxes less painful in April.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

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