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Luke Delorme: A (tax) silver lining for investors in a rough market | Business

Traders on Wall Street

Traders work on the floor at the New York Stock Exchange recently in New York. The markets have taken a beating in 2022, but a process called tax swapping can help investors offset some of those losses.

Stocks and bonds have been beaten up in 2022. Major stock market indices such as the Dow Jones Industrial Average and the S&P 500 are down 15 and 20 percent at mid-year.

Bonds haven’t done investors any favors. A typical bond index is down more than 10 percent this year as interest rates have risen. There are few if any investment categories that have provided positive returns.

Nonetheless, experienced investors know that markets rise and fall. The positive long-term gains associated with putting your money at risk comes at a cost. The short-term pain investors are feeling today could be thought of as the fee for admission into markets. You can’t get a return in the long run without suffering occasionally in the short-term.

Don’t despair. Investors are all in the same boat and we’re all suffering together. Moreover, there are silver linings, and you don’t have to be Warren Buffett to seize them. For investors with taxable brokerage accounts, one such opportunity is to capture tax losses. Investment professionals refer to this as tax swapping.

The idea is to sell positions that have capital losses and immediately buy back similar but not identical positions. Recognizing capital losses can help offset future capital gains for tax purposes and can even be used to offset up to $3,000 of ordinary income per year.

Be careful. If you buy back the same security or one that IRS would deem to be “substantially identical” within 30 days of the sale, the trade would be considered a wash sale and the capital loss will be disallowed for tax purposes. However, you ought to be able to find a similar but not identical security.

For example, let’s say you bought $10,000 of an S&P 500 Index Fund from SPDR with your extra savings at the end of last year. That fund is now down roughly 20 percent, or close to it depending on when you’re reading this. You can choose to sell the SPDR fund and use the proceeds to buy a similar large cap index-type U.S. stock fund from another fund provider such as iShares, Vanguard or countless others.

Your overall exposure to the market will remain nearly the same. You’ll still hopefully eventually realize the positive long-term returns that are typically associated with investing in the stock market. However, this transaction allows you to recognize a roughly $2,000 short-term capital loss. That loss can be used to offset capital gains later in the year. If you don’t have any capital gains, it can be used to offset ordinary income. If you fall in the 24 percent marginal tax bracket, you’d save $480 on your federal taxes next year.

If you have taxable investments in stock or bond mutual funds or ETFs that you’ve purchased in the last two years, you likely have unrealized losses that can be captured. Note that this is not applicable within tax-deferred accounts such as IRAs or 401(k)s.

These rules also apply to individual stocks. Compared with funds, it is difficult to find a stock similar to one you might want to sell. But you could capture the tax loss and buy, for example, a fund in the same sector as the stock you sold.

Let’s say you bought Apple and Microsoft stocks at year-end. You’re down somewhere between 20 and 25 percent on your position. You could choose to sell those positions, recognize the losses for tax purposes, and buy an ETF representative of the technology sector. You would still have exposure to the tech sector and you’d get a tax break this year.

If you end the year with more than $3,000 in capital losses, you can carry over the excess to future tax years. For instance, if you have $9,000 in capital losses this year, you could conceivably offset $3,000 ordinary income for each the next three years, assuming you have no capital gains to offset in any of those years.

As always, consult with a tax professional before making any decision. I am not a tax professional, and this is not personalized tax or investment advice. A good investment adviser will be attuned to opportunities to capture tax losses. Check in with your adviser to see what they’ve done so far this year, and coordinate with your tax professional. This is an opportunity to make the most of a rough year in the markets.

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