Tax Loss Harvesting: How to Cut Losing Stocks and Save on Taxes

As much as I love the holidays at the end of the year—the cooking, decorating, entertaining—all of those fun things, one thing I dread as the year wraps up is always in the back of my mind. You guessed it—taxes!

Don’t get me wrong; I’m grateful that I have an income, and I really don’t mind contributing to many government programs that require my taxes to fund, but—like everybody else—I wish I didn’t have to pay so much!

Consequently, I’m always on the lookout for ways to reduce my tax liabilities. In this article, I’m going to concentrate on two categories that can really help you reduce your tax outlay: home deductions and credits, and investment strategies will help you keep more of your money—legally—from Uncle Sam’s coffers.

Let’s begin with the 2022 tax brackets. That way, you’ll be able to decide just where you may need some tax advice:

2022 Federal Income Tax Brackets

(For Taxes Due in April 2023)

Single filers

Married, filing jointly

Source: Nerdwallet.com

Now, let’s review some of the best home deduction strategies—some you will know about, and some with which you may not be familiar.

The Best Home-Related Deductions and Credits

Refinancing Points. If you took advantage of lower interest rates earlier this year, you can deduct your refinancing points, but only over the life of your loan. If your loan is for 15 years, that means you can deduct 1/15 of them for 2022; if 30 years, your deduction will be 1/30 of the points for this year.

However, if you took money out of your refinancing to improve your home, you may be able to deduct the points related to the improvements right away.

Mortgage Points Deduction. If you bought a home in 2022, you can deduct the points you paid to the lender—all in one year, as long as it is your primary home. However, if you bought a second home, those points will have to be amortized over the life of the loans (the same as in refinances).

Property Tax Deduction, up to $10,000 ($5,000 if you’re married but filing a separate return) on the combined amount of state and local income, sales and property taxes you can deduct.

All three of the above deductions can only be taken if you itemize, instead of using the standard deduction.

Mortgage Interest Deduction. Before the 2017 Tax Cuts and Jobs Act, the limit for mortgage interest deduction was $1 million. But for 2022, the limit dropped to $750,000, so married couples filing together and single filers can deduct the interest as high as $750,000. Married taxpayers filing separately can deduct as high as $375,000 each.

There are some exceptions:

· For mortgages taken out prior to October 13, 1987, there is no limit to deductible interest.

· Homes bought after October 13, 1987, and prior to December 16, 2017, are eligible for the $1 million limit. If married and filing separately, that number becomes $500,000 each.

· Homes sold prior to April 1, 2018, are still eligible for the $1 million limit—if there was a binding contract signed prior to December 15, 2017, that closed prior to January 1, 2018, and the house was bought prior to April 1, 2018.

Home-Office Expense Deduction. This has been sort of a muddle since COVID, with so many folks working from home. But here are the latest IRS rules:

For self-employed folks who work at home, the home-office deduction may be available for homeowners and renters. It doesn’t matter what type of home you have; boats and outbuildings can even be included.

The caveat: you must use part of your home regularly and exclusively for your business. If you do so, you can deduct a portion of your utility bills, insurance costs, general repairs, and other home expenses. Part of your rent can also be deductible. If you own your home, you can write off depreciation.

There are two methods for calculating this deduction:

Actual expense method., Multiply the expenses of operating your home by the percentage of your home devoted to business use.

Simplified method. Deduct $5 for every square foot of space in your home used for a qualified business purpose. The maximum size allowed is 300 square feet.

For remote employees—forget about it! Before 2018, employees could claim home-office expenses as a miscellaneous itemized deduction if the costs exceeded 2% of their adjusted gross income. But the 2017 Tax Cuts and Job Act killed that deduction.

Credits for Energy-Saving Improvements. If you install certain energy-efficient equipment in your home, you may be eligible for a tax credit. It’s 30% on qualifying new systems that use solar, wind, geothermal, biomass or fuel cell power to produce electricity, heat water or regulate the temperature in your home. The credit for fuel cell equipment is limited to $500 for each one-half kilowatt of capacity. (Beginning next year, the credit won’t apply to biomass systems, but it will apply to battery storage technology.)

And this year, you can also get a credit of $500 by installing energy-efficient insulation, doors, roofing, heating and air-conditioning systems, wood stoves, water heaters, or the like. New energy-efficient windows will get you a credit of up to $200. And there are a few other available credits, including for advanced main air circulating fans ($50), certain furnaces and boilers ($150), and energy-efficient building property ($300).

Please note that these types of credits change every year. In the past, I’ve received credits for buying a hybrid vehicle and installing insulation in my crawl space!

Credit for Electric Vehicle Charging Equipment. If you have an electric vehicle, you’ve probably received a tax credit for buying it. But did you know that if you have installed charging equipment at your home you can also receive a credit of 30% of the costs of the qualifying equipment, up to $1,000?

Deduction of Medically Necessary Home Improvements. Sometimes, modifications to our homes must be made to accommodate certain medical conditions. Homeowners often add ramps, expand doorways, lower cabinet heights, relocate electrical outlets, install elevators or stair lifts, and install handrails. These upgrades may qualify for a medical expense deduction. And the operation and maintenance of the upgrades may also be deductible as medical expenses. The caveat is that they must be deemed “medically necessary.”

Landlords May Deduct Rental Expenses, even if you are just renting out a room or a section of your home (not necessarily an entire house). While you will pay taxes on the income you receive for the rental, you may be able to deduct insurance, repair and general maintenance costs, real estate taxes, utilities, supplies, depreciation (on that part of the house and any furniture and equipment you provide) and more.

Capital Gain Exclusion When Selling Your Home. Also being in the real estate business, I really love this one!

Most folks will not have to pay taxes on the sale of their homes as long as your gain is not more than $250,000 if you’re single and $500,000 if you’re married…and if you:

· Have owned the home for at least two of the past five years

· Have lived in the home for at least two of the past five years

· Haven’t used this exclusion to shelter gain from a home sale in the last two years

This is pretty easy to calculate. Recently, I sold a home for $1.5 million. The owners were aware of this rule, so they waited until last June to list it, as that was their two-year mark. But they bought the home for only $847,000. So, their gain would be $653,000. $500,000 can be excluded, but that leaves $153,000 that will be taxed. Or maybe not. Read on.

You may still be able to exclude a portion of your gains if you sold due to a change in your workplace location, a health issue, or a divorce.

Increased Basis When Selling Your Home. If you have gains above the above exclusions, you can try to adjust the cost basis of your home by deducting some of the following costs from your gains:

· Certain settlement fees and closing costs you paid when you bought the home.

· If you owned a plot of land on which you built a home, you may be able to include the cost of the land, architect and contractor fees, building permit costs, utility connection charges, and related legal fees.

· Costs for any additions and major home improvements. This does not include your normal repair and maintenance expenses. This is where my sellers in the above scenario may get lucky. They’ve told me that they have spent $300,000 on improvements since they purchased their home. If they can prove that to the IRS, then they may not have to pay any taxes on that $153,000. It would look like this: $1.5 million - $847,000 - $300,000 = $353,000. If the IRS allows all those improvements, my sellers won’t have to pay capital gains on their sale.

As with all tax matters, I would recommend that you strategize with your tax advisor to determine which of these deductions/credits you may be allowed to use.

Now, let’s look at some investing strategies that will reduce your tax nut.

Maximize Your 401k and IRA Contributions

Adding to your 401k should be a no-brainer—for lots of reasons: adding to your retirement monies, taking advantage of employer-matched funds, the wonderful aspects of compounding, and reducing taxes because your contributions are pre-tax, which serves to lower your taxable income.

Traditional IRAs may also be funded with pre-tax dollars that will reduce your tax bill.

Here are the allowable contributions for 2022:

The maximum allowable 401(k) contributions:

$20,500 up to age 49

$27,000 for age 50+ (with $6,500 catch-up contribution)

For the current tax year, the maximum allowable IRA contributions:

$6,000 up to age 49

$7,000 for age 50+ (with $1,000 catch-up contribution)

Consider a Roth IRA Conversion

A Roth IRA is subject to income limits as you can see in the table below.

Source: Nerdwallet.com

You may recall that Roth IRAs are not subject to income taxes at the time of withdrawal in retirement, as you contribute after-tax dollars to them. And Roth IRAs are tailor-made for investors just starting out in their careers, as they probably will meet the income qualifications. Best of all, your assets will accumulate tax-free in your Roth IRA and allow for tax-free distributions in the future when your income tax rates may be higher.

However, you need to be aware that conversion to a Roth IRA is considered a taxable event during the conversion year. That means that any pre-tax contributions that you have made and all earnings that have been added to your account will be added to your gross income and taxed as ordinary income.

You may want to consider a conversion if you:

1. Believe the tax rates on your future income will rise

2. Have other sources of cash that can be used to pay the extra taxes incurred from the conversion

3. Won’t be leaving any IRA assets to charity

4. Anticipate that your IRA will last for many years

5. Are nearing retirement, and expect to have little earnings during your golden years

6. In a down market (like 2022), your retirement assets may have taken a hit, which means conversion taxes won’t hurt nearly as much

The best way to figure out if you should convert to a Roth IRA is by doing a break-even analysis.

I found this example on Motleyfool.com, which I think will be helpful to you.

“David and Janice, both in their mid-70s, were contemplating moving their traditional IRA assets into a Roth. The reason was simple: Their RMDs from a traditional IRA exceed their living expenses. In addition, by having a higher income, they may be subjected to increased Medicare premiums or a higher hurdle for deducting medical expenses on their tax returns. But by moving their assets to a Roth, they would not be required to take—or pay taxes on—distributions they did not need.

“In this scenario, a Fool Wealth planner can assist with performing a breakeven analysis. Notably, this example assumes that leaving a legacy was not a priority for the clients. The results from this analysis are as follows:

Source: Motleyfool.com

“The analysis shows that David and Janice’s breakeven for a Roth conversion would be 14 years. So, each would be well into their 80s before the switch made tax sense.”

I would recommend that you get some professional advice from your tax accountant or attorney to determine whether a conversion to a Roth IRA would be beneficial to you in your tax strategy.

Tax Loss Harvesting: How to Cut Losing Stocks and Save on Taxes

If you are sitting on some investment losses (which many folks are!), now may be the time to sell them and offset those losses against any gains you may have accrued in your portfolio.

Tax-loss harvesting (also called tax swaps) is simply a tax-efficient strategy that involves selling taxable investment assets—including stocks, bonds, and mutual funds—at a loss, in order to reduce your tax liability. All you do is apply this loss against any capital gains in your portfolio, and that, effectively, will reduce your overall capital gains taxes.

If you have had more losses than gains in 2022, the IRS will let you apply up to $3,000 in losses against your other income. And then you can carry over any remaining losses to offset income in the future.

Below is a graphic from Vanguard that gives a fair representation of what happens when you utilize tax-loss harvesting.

Here are some examples of tax-loss harvesting:

Scenario 1: You sell shares of XYZ Company and lose $4,000. Then you sell shares of ABC Company for a gain of $5,000. You’re ahead of $1,000 and would normally pay capital gains taxes on that $1,000 gain. You have offset your total gain by the $4,000 loss you took on the shares of XYZ Company.

Scenario 2: Now, what if you actually lost $6,000 on the sale of XYZ Company shares? And let’s pretend that you still sold your shares of ABC Company for a $5,000 gain. So, you’re in the hole by $1,000. But the IRS lets you carry that loss over to apply to your regular income, up to $3,000 per year. So, you are effectively reducing your income.

Scenario 3: Next, let’s say you lost $10,000 on selling the shares of XYZ Company. And you still sold ABC Company shares for $5,000. Now, you have a net loss of $5,000. Well, the IRS says you can only use $3,000 of that loss to reduce your income this year. However, next year, you have another maximum $3,000 of offset. So, you can take the remaining $2,000 loss from this year and reduce your income by $2,000 next year.

Here’s a graphic from Schwab that demonstrates the mechanics of a tax swap.

Source: Schwab Center for Financial Research.

The ultimate goal of using this tax-loss harvesting strategy is to defer income taxes many years into the future, hopefully, after you retire, when you’ll probably be subject to a lower tax bracket. And along the way, your portfolio will continue to expand as you are deferring taxes on your gains, instead of depleting the portfolio to pay capital gains taxes each year.

There are five specific keys to successful tax-loss harvesting:

1. You must calculate your cost basis for the shares you are selling. Cost basis is what you paid for the investment, and the gain/loss is the sale price minus the cost basis. It will benefit you to use specific identification of shares, as that allows you to know your exact loss/gain, unlike the average cost basis, which spreads the loss/gain out evenly. You also don’t want to use FIFO (first in, first out), which will minimize your loss potential since the price of your oldest shares are least likely to be down. The point is to sell your most expensive shares so that you can show the biggest possible losses. Most of the brokers you use for buying and selling shares will offer specific identification of your shares.

2. You should know that while tax-loss harvesting can reduce this year’s tax bill, the process automatically lowers the cost basis of the investment—which means future capital gains could be taxed at higher rates. Let’s look at an example:

You harvest a capital loss by selling an investment with a cost basis of $40,000 when the price drops to $35,000.

Using the capital loss of $5,000 (cost basis of $40,000 minus sale price of $35,000) to offset the same amount of capital gains, they could lower this year’s tax bill by $750 (15% capital gains tax x $5,000 = $750.)

But harvesting the capital loss has lowered your cost basis because you will probably reinvest that $35,000, which is your new cost basis (as opposed to the $40,000 you started with). And that means if the investment rises to, say $45,000 again and is sold, the capital gain will be $10,000. That gain at a 15% capital gains tax would result in taxes of $1,500, which is actually twice what your $750 savings were. Bottom line, in this scenario, tax-loss harvesting resulted in costing you more in taxes.

3. You must take into consideration your short- and long-term capital gains rates. Short-term investments (held less than one year) are taxed at ordinary income tax rates (which, for most investors, are higher than capital gain tax rates). Long-term assets are taxed at the lower capital gains tax rate which, for most investors, is 15%. Check the table below for 2022 capital gains tax rates.

Capital gains tax rates for 2022

Source: IRS

If you have short-term gains, it may be advisable to use capital losses to offset income rather than capital gains.

4. Beware the wash-sale rules. The IRS says that you can’t claim a loss on the sale of an investment if the same or “substantially identical” investment is purchased either 30 days before or after the sale date. It’s important to note that the wash-sale rule applies to all accounts, including your tax-deferred accounts. That means that if you sell a stock in your brokerage account and buy the same stock in your IRA account within the waiting period, you will trigger the wash-sale rule. And if you’re married, you and your spouse cannot use each other’s accounts to get around the wash-sale rule.

Unfortunately, the IRS isn’t exactly clear in defining what would make a replacement security “substantially identical” to the one sold for the purpose of harvesting a capital loss. Consequently, you’ll need to be very careful with your investment replacement. One way to do that is by buying a mutual fund or ETF that will give you exposure to the industry of the security that you sold.

One last note on wash sales: If you decide to wait the 30 days after your sale to repurchase a like security, be aware that you may be out of the market at just the wrong time if a bull run occurs.

5. IRS restrictions require that a long-term loss would first be applied to a long-term gain, and a short-term loss would be applied to a short-term gain. If any category has excess losses, they can be applied to gains of either type.

Now, you should know that you aren’t just limited to using equities for tax-loss harvesting. You can also use funds, ETFs, and bonds.

And tax-loss harvesting applies only to taxable accounts; since your 401k and other retirement accounts are most likely tax-deferred, you would not use this strategy for those accounts. If you are a high wage-earner, subject to the 32%, 35%, or 37% tax bracket, tax-loss harvesting may be especially beneficial to you, as you may be able to defer taxes until later years when your tax bracket is lower.

And as I mentioned earlier, in a bear market, such as we have seen for most of 2022, tax-loss harvesting may set you up for some carry-forward losses that can offset part of your income for many years to come. It would be a great time to take advantage of this, as these kinds of markets don’t come around too often. In fact, in the last 10 of 13 years, the S&P 500 has gained ground. And one note that should put a smile on your face: There is no expiration date on capital losses. As long as you have them, you can continue offsetting your gains up to $3,000 per year, ad infinitum.

You should also know that you don’t need to just use tax-loss harvesting at the end of the year. It can be employed anytime during the year when you have losses, especially after a particularly depressed market. But please consult your tax advisor if you intend to utilize the tax-loss selling strategy.

How to Find Tax-Los Harvesting Opportunities

As you can see by the following chart, Energy was the only sector to actually show gains so far in 2022

U.S. Sector

Source: SeekingAlpha.com

No doubt, you may own a few stocks in the losing sectors, so now may be a great time to sell some of your losing positions to offset any gains that you may have.

And there are lots of stocks that have seen major price erosion in 2022.

Just for fun, I searched for stocks that had fallen 10% or more from their 52-week highs. Even I was surprised by the results—a total of 7,015 stocks out of my database of 8,377 stocks! I got even more curious and found that 2,401 stocks had fallen more than 50% from their 52-week highs, and 413 stocks had fallen more than 90%! And the companies in that last category are not just obscure companies that you may have never heard of. They include these stocks:

· Mail order food delivery company Blue Apron Holdings, Inc. (APRN), trading at 1.14 per share; five years ago, the shares were more than 60.

· Auto reseller Carvana Co. (CVNA), trading at 8.55; it was more than 337 per share two and a half years ago.

· Vaccine darling Novavax, Inc. (NVAX), trading at 21.47; it was more than 138 a little more than a year ago.

· Insurance broker SelectQuote, Inc. (SLQT), trading at 0.73; it was trading for more than 31 in April 2021.

If you own any of these companies, they may be ripe for tax-loss harvesting!

But I digress. I’m not interested in stocks that have lost most of their value. That’s a little too speculative for me! So, I went back to those 7,015 stocks that had fallen more than 10

Next, I was thinking—how many of these stocks actually look severely undervalued?

I narrowed my search again, using the following parameters:

· Positive institutional transactions

· Positive insider transactions

· Analyst ratings of Strong Buy

My search resulted in 52 names, representing the Healthcare, Financial, Communication Services, Industrials, Real Estate, Technology, Consumer Cyclical, Consumer Defensive, Basic Materials, and Utilities—basically all industries.
Lastly, I looked at the technical analysis of each of those stocks, and came up with six companies that looked pretty interesting.

They are:

You’ll notice that five out of the six companies are biotechs, which tend to be pretty speculative. Most of these companies aren’t making any money, but the utility company is profitable, having beat both earnings and revenue estimates in the last quarter. It also pays a dividend yield of 1.77%.

My take: The utility company looks like the safest bet. But if you are looking for some excitement and the possibility of a ten-bagger, you may want to consider one of the biotechs.