In another post, I’ve written about using capital losses to offset capital gains to help manage your income tax bill. But, to a limited extent, you can deduct capital losses from ordinary income. This can be useful if your ordinary income tax rate is higher than your capital gains tax rate.
Here’s an example. Let’s say you earn $350,000 per year and your marginal income tax rate is 35% and your long-term capital gains tax rate is 15%. If you realize a capital loss, you can deduct up to $3,000 of that loss against your ordinary income. At 35%, that means you can save $1,050 in income taxes by realizing the loss and deducting it against your ordinary income.
Alternatively, you could use the capital loss to offset a capital gain. But that gain (if it’s a long-term capital gain) is only taxed at 15%. So if you use a $3,000 loss to offset a $3,000 long-term gain, you save only 15% of $3,000, or just $450.
Three Keys to Remember
It’s important to remember that taxes are the tail and not the dog. Buying and selling investments should be about big picture financial goals, not about taxes. Don’t buy and sell mutual funds or ETFs just for tax reasons.
Second, as you make tax-related moves, it is important to maintain your overall target asset allocation. Stay in tune with your overall plan and think about taxes in a tactical way, but remember your long-term strategy.
Third, as you consider tax-related decisions, be sure to consult your accountant. A good financial advisor can help you strategize and keep focused on the long term, but it is also important to have your tax advisor involved as well.
At Dominion Financial Advisors, we view the role of the financial advisor as a coordinator of your financial life. We provide input, you make the decisions, and we all may do better when we work in partnership with the other advisors in your life. If you think our values align with your values, then schedule a consultation or contact us to find out how we can help you with financial planning and wealth management.