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HOW YOU COULD BENEFIT FROM TAX-LOSS SELLING THIS YEAR

The U.S. market gained more than 25% for the year to date through mid-December
2024. That’s a healthy showing by any measure. It doesn’t seem like it would be
a market environment that’s conducive to tax-loss selling.

But unless your strategy is to buy only U.S. stocks, you may indeed have
opportunities to realize tax losses in your portfolio, which you can use to
offset gains elsewhere. That’s because other market segments haven’t performed
nearly as well.

Must-knows about tax-loss selling

It’s important to note that tax-loss selling is only a worthwhile strategy if
you have taxable accounts. To benefit from a tax loss that in turn can help you
save on taxes, you need to find holdings in your taxable portfolio that are
trading below your cost basis — your purchase price adjusted upward to account
for any commissions that you paid along with reinvested dividend and capital
gains distributions.

There are different methods for determining cost basis. The specific share
identification method for cost-basis elections provides the most opportunities
for tax-loss selling or gain harvesting because it allows you to cherry-pick
specific lots of a security to sell. But it’s important to note that the average
cost basis is usually the cost-basis election default for mutual funds, while
the default cost basis election for individual stocks is often first in, first
out. In other words, unless you select a different cost-basis election before
selling, your investment firm will report your loss or gain using the default.

If you sell securities and your sale price is lower than your cost basis, you
have a capital loss. That loss, in turn, can help offset taxable gains elsewhere
in your portfolio. (With many mutual funds again poised to make big capital
gains distributions in 2024, those losses could come in handy.) If you don’t
have any gains in the year you realize the losses or your losses exceed your
gains, you can use the losses to offset up to $3,000 in ordinary income. Unused
losses can be carried forward indefinitely and applied against future taxable
gains.

Where to look for tax-loss sale candidates

As 2024 winds down, here are some of the most fruitful spots to look for
tax-loss candidates.

Long-term bond funds and ETFs: Despite the Federal Reserve’s interest-rate cuts,
many bond funds are still in the red over the past year and over the past three
years as well. Long-term bonds and bond funds look especially ripe for tax-loss
selling. Losses in intermediate-term bonds haven’t been as deep — 2% annualized
losses over the past three years — but still could add up to a decent-sized loss
if your position size is large. Moreover, tax-loss selling may provide a hook to
improve your total portfolio’s asset location, in that fixed-income holdings are
often best situated in tax-sheltered accounts rather than taxable ones. With
yields surging, being smart about asset placement now matters more than it did
when yields were exceptionally low.

Individual stocks: Individual stock investors have the easiest pickings when it
comes to unearthing tax-loss sales. Even if your portfolio has performed well in
aggregate, it’s likely that something you own has lost value since you purchased
it. For the year to date through mid-November, about 1,100 US stocks with market
caps of more than $1 billion had losses of 10% or more. You may even be seeing
red on positions you’ve owned for a while: Roughly 1,200 individual US companies
with market caps of more than $1 billion had 10% or greater losses over the past
three years.

Other places in your portfolio to look are non-US stock funds, sector funds and
short and alternative funds. For the latter, it’s no surprise that investors who
own funds and ETFs that bet against stocks have struggled recently, given the
strength of stocks’ gains this year.

Next steps

If you sell a security for a loss, you can go ahead and replace it with
something similar right away, provided the new holding isn’t so close that the
IRS considers it “substantially identical.” Immediately replacing an actively
managed fund with an index fund or ETF would be fine, for example. But swapping
an index fund for an ETF that tracks that same index would run afoul of the
wash-sale rule, in that they’re substantially identical securities. In that
instance, the IRS would disallow the loss. And if you wait 30 days after selling
the losing security, you can replace it with the very same security and still
claim the loss.

You should also consider tying tax-loss selling along with a broader portfolio
review and cleanup effort.

—

This article was provided to The Associated Press by Morningstar. For more
personal finance content, go to  https://www.morningstar.com/personal-finance

Christine Benz is the director of personal finance and retirement planning at
Morningstar.

Related links:

— The best investments for taxable accounts

— Ready for a big capital gains tax bill?

— Which investments to keep out of your taxable account

How tax-management options are expanding

This article was written by By The Associated Press and first appeared on
MarketBeat.com.

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