In the September 17th post, Gerri discussed what market volatility was. The volatility of the market currently has many people worrying about their investment accounts. Did you know there are ways to capitalize on this volatility?
Many people are seeing decreased balances in their investment account. If you have a non-retirement account, you may have the ability to take advantage of tax harvesting. Look at the assets you are holding in your non-retirement accounts. Are any of the current values lower than the price you paid for those assets? If the current price is lower than your purchase price, you can sell the asset and take the loss on your tax return. Retirement accounts such as IRAs, 401(k)s, and 403(b)s do not qualify for tax harvesting.
Disclaimer: Some of the examples herein are strictly hypothetical in nature. Keep in mind that the market, as well as both the rate of return and principal value of securities, will fluctuate over time. When considering purchasing specific investments, you should note that past performance is not necessarily indicative of future performance.
For example, if you purchased 100 shares of GAH Inc on February 7, 2018, for $100.00 per share and the price per share has dropped to $75.00, you have a tax loss if you sell GAH Inc shares. The loss is calculated by taking the original purchase price of $100.00 per share and subtracting the current price of $75.00. This gives you a $25.00 loss per share of GAH Inc that you sell. Selling all 100 shares would give you a total GAH Inc loss of $2,500 to claim on your tax return. The loss drives down your taxable income and your tax liability.
You can pair the stock loss with selling stocks that have a gain that you have been putting off because you did not want to pay the taxes on the gains. You own 100 shares of JMD Inc that you purchased for $10 a share and the price has risen to $100 per share. You now have a $90 profit on each of the 100 shares, a total gain of $9,000. Depending on your income, current capital gains rates are 0, 15, or 20%. Tax on the $9,000 gain would be $0, $1,350, or $1,800, which is far less than ordinary income rates, which range from 10 – 37%.
If you were to sell the GAH Inc stock at a loss of $2,500 and you sold JMD Inc for a profit of $9,000, the two would net on your tax return. This would give you a taxable gain of $6,500 on your tax return. Capital gains taxes would be $0, $975, or $1,300, depending on your income. You have also generated $17,500 cash to buy additional stock after paying the taxes.
There is a double benefit to tax harvesting: the loss on your tax return and putting cash to a different use. In the example of the sale of GAH Inc, you have generated $7,500 of funds to purchase additional stock. Because the price of most stocks is currently down, you now have the ability to potentially buy low and ride the stock price back up if the market recovers. Pay attention when buying and selling the same stock. If you sell shares of a stock for a loss and repurchase the same stock within 30 days of the sale, you have created a wash sale. You are not allowed to take the loss on a wash sale on your income tax return. If you sell stock on June 1 for a loss and buy the same stock on June 15, the June 1 sale is not allowed to be taken. If you sell on June 1 and buy the same stock on July 2, you can take the June 1 loss on your income tax return. Tax harvesting works for stocks, mutual funds, bonds, and all types of investments.
Another thought to consider is investing in stocks that pay decent dividends. The price might not fluctuate for great profit, but having a steady dividend income can make up for that. Dividends are classified as ordinary dividends or qualified dividends. Ordinary dividends are taxed at ordinary income rates. Qualified dividends follow the capital gain tax rates. If you are looking to add dividend-paying stocks to your investment portfolio, make sure to have an extensive discussion with your financial planner regarding the need for qualified dividends to ensure you are not paying higher tax rates.
Lower markets make now the ideal time to think about Roth conversions. If you converted your Traditional IRA money into your Roth IRA, as the market recovers, all the growth in your Roth IRA is tax-free. Again, you are buying low and riding the price up. If you had left the money in your Traditional IRA and while the market recovered, all the growth would not be tax-free, just tax-deferred. As we discussed in the April 30th post, tax rates are lower now than in previous years, another good reason to consider a Roth conversion.
These are just a few of the ways you can take advantage of current market volatility. Taking one of these ideas and applying it to your investment strategy can be far better for you than doing nothing and leaving your investments as they are. Thinking about making one of the changes discussed here? Make sure you discuss the idea with your financial planner and your tax preparer as well. If you do not have a financial planner, please give Planning with Purpose a call, we would love to help you work toward the future you want.