After three straight years of positive gains, the S&P 500 (^GSPC) is set to close 2022 down roughly 20%.
For investors looking to offset any realized capital gains throughout 2022, this year's market nosedive could work in their favor.
“Anything that's considered capital gain could be potentially offset with capital losses that come from traded securities,” Rocco Carriero, a private wealth advisor, told Yahoo Finance. “It's one of the great benefits of how the American tax system is set up. It encourages people with risk.”
A tax provision known as tax loss swapping or tax loss harvesting can help investors offset their realized gains this year with losses — as long as the losing trades are executed prior to the close of the market on the final trading day of the year. This year, the deadline is Dec. 30 at 4pm ET.
The swap uses losses in the market to offset capital gains. For example, if an investor sold a stock this year that they owned for more than 12 months, they would most likely be taxed at either a 15% or 20% rate depending on their income. As a result, $10,000 in gains could mean owing $1,500 come tax season. But if that same investor sold capital losses of $15,000, the losses would be worth more than the capital gain, therefore canceling out any taxes owed.
Carriero noted that there are some exceptions that could limit tax swapping opportunities and recommended checking with a tax professional, especially since one issue that can arise is the "wash sale rule." This rule dictates that an investor can not buy an equity sold at a loss within the next 30 days.
If the investor avoids the wash sale rule and their reported capital losses are more than the reported gains, the investor will have options. An investor could carry over their $5,000 left after offsetting the year’s gains to offset future income or capital gains. This is known as tax loss harvesting.
Tax filers can decide to use up to $3,000 in losses per year to subtract from their annual taxable income.
“It may not lower your income tax bracket, but it should save you some income tax dollars,” Carriero said.
However, investors could opt to not use the extra losses toward their annual taxable income and instead wait to offset a future capital gain with their accrued capital losses.
The capital losses can be carried over indefinitely, according to Carriero, meaning that selling a large amount of losses during a down market could help offset gains from the next bull market.
Carriero suggested that investors should consider their time horizon when deciding if it's time to sell their losses at the end of the year and tax-loss harvest. If an equity is sold at a loss by year-end in 2022 but bought back in the first 30 days of trading in 2023, it no longer counts as a loss.
This means the capital gain wouldn’t be canceled out. This reversal, known as the wash-sale rule, can come into effect whether the investor buys the equity back themselves or a mutual fund purchases the stock without the investor knowing.
Josh is a reporter and producer for Yahoo Finance.
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