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2020 Tax Planning Tip: Keep taxes to a minimum on investments in taxable accounts

October 15, 2020

Harvest investment losses to help lower your tax bill.

One way to reduce the taxes on your capital gains and ordinary income is to sell some investments that have decreased in value since you bought them.

When you sell a stock, mutual fund, or other security in a taxable account at a loss, you can use that loss on your tax return to reduce the capital gains and up to $3,000 ($1,500 is married filing separately) of the ordinary income you must pay taxes on. And if your loss is not fully used on this year’s tax return, the unused portion of it can be carried forward and used in future years.

This strategy is known as tax-loss harvesting. Here’s a simplified example of how it works:

Let’s say that you sell Stock A at a $10,000 profit this year and Stock B at an $8,000 loss on your tax return to reduce the $10,000 capital gain so that you only have to pay tax on $2,000 of it.

Let’s also take a look at what might happen if your loss was $25,000 instead of $8,000. In this scenario, the loss totally offsets the $10,000 capital gain so you do not owe any tax on the gain. Plus $3,000 of the remaining $15,000 loss can be deducted from your ordinary income, which lowers your taxes for the year even more. At this point, you still haven’t used all of the loss and can use the remaining $12,000 in future years to reduce the capital gains and ordinary income you must pay taxes on.

When harvesting tax losses, be careful not to buy a substantially identical security within 30 days before or after the sale. If you do, you will have what is known as a wash sale and cannot deduct the loss on this year’s tax return.

Give appreciated securities to family members who are eligible at a lower tax rate.

Do you normally give cash to family members? If they are eligible for a lower tax rate on capital gains than you are, you may want to give them appreciated securities to sell rather than selling the securities yourself and giving them the cash. But be sure to consider the kiddie tax before using this strategy.

New in 2020: The kiddie tax is once again based on the parent’s tax rate.

If your young child’s interest, dividends, capital gains, and other unearned income exceed $2,200 this year. The excess will generally be taxed at your tax rate.

This method of taxing children’s unearned income is known as the kiddie tax and generally applies to the unearned income of children under age 19, or age 24 if a full-time student, that exceeds the $2,200 threshold.

Be sure to consider the kiddie tax before giving securities to your younger children. Of course, once your child reaches the age limit all of his or her unearned income will be taxed at his or her own tax rate, which may be considerably lower than yours.

Key take-away:

  • Harvest investment losses in your taxable accounts by December 31, 2020 to lower your tax bill.
  • If you sell a security at a loss in order to use the loss on this year’s return, do not buy a substantially identical security within 30  days before or after the sale.

We can assist you with these and other tax savings strategies so please reach out to us in Williston (802.878.1963) or Rutland (802.775.7132) for personalized advice.

This article is published in the November 2020 edition of Eye on Money. If you would like to be added to Copper Leaf Financial’s mail list for this publication please email jennifer@dh-cpa.com