The U.S. market has experienced an impressive gain of over 25% year-to-date as of mid-December 2024, indicating a solid market performance. This trajectory, however, may not seem to favor tax-loss selling, a strategy often utilized by investors looking to offset capital gains.
For individuals who diversify beyond U.S. equities, there are still opportunities to realize tax losses within your investment portfolio. Many market sectors have not mirrored the robust performance of the overall market, offering potential avenues for tax-loss selling.
It’s crucial to understand that tax-loss selling only applies if you hold taxable accounts. To capitalize on a tax loss, you must identify assets in your taxable portfolio that are currently valued lower than your cost basis— the original purchase price adjusted for any commissions and reinvested dividends or capital gains.
Various techniques exist for determining cost basis. The specific share identification method can maximize tax-loss selling opportunities as it permits the selection of particular lots of a security for sale. Conversely, mutual funds typically default to the average cost basis, while individual stocks often default to a first-in, first-out method. Hence, unless you specify a different cost-basis method before executing a sale, your investment firm will apply the default settings to report any gains or losses.
When you sell securities for less than your cost basis, you incur a capital loss. These losses can subsequently offset taxable gains in other areas of your portfolio. As many mutual funds are expected to distribute significant capital gains in 2024, these losses can prove advantageous. Should your losses surpass your gains or if you have no gains in the year, you can use the losses to reduce ordinary income by up to $3,000. Remember, any unrecovered losses can be carried forward indefinitely to counter future taxable gains.
As the year draws to a close, certain investment categories are prime targets for tax-loss sales. Long-term bond funds and exchange-traded funds (ETFs) continue to see declines despite recent Federal Reserve interest rate cuts. Over the past three years, long-term bonds have particularly underperformed, making them viable for tax-loss selling. Though intermediate-term bonds have experienced milder losses—averaging around 2% annually—they too could contribute to a meaningful overall loss if you hold a significant position. Furthermore, utilizing tax-loss selling can help optimize your portfolio’s asset distribution, as fixed-income investments are generally better held in tax-advantaged accounts.
Investors in individual stocks may find the greatest opportunities for tax-loss selling, as even well-performing portfolios typically contain some underperforming shares. Through mid-November of this year, approximately 1,100 U.S. stocks with market caps exceeding $1 billion have faced declines of 10% or more. Numerous long-held positions might also be in the red; around 1,200 companies with similar market capitalization suffered losses of at least 10% over the last three years. Other areas worth examining for tax-loss candidates include non-U.S. stock funds, sector-based funds, as well as short and alternative funds, particularly as those bet against stocks have fared poorly in light of robust stock market performances.
If you decide to sell a security at a deficit, you can replace it with a similar investment immediately, as long as the new asset is not so closely related that the IRS would deem it “substantially identical.” For instance, replacing an actively managed fund with an index fund or an ETF is permissible; however, exchanging one index fund for another tracking the same index would violate the wash-sale rule, leading to a disallowance of the claimed loss. To avoid this, you could wait 30 days after the initial sale before reacquiring the original security.
It is also wise to incorporate tax-loss selling into a comprehensive portfolio review, allowing for a fresh assessment of your investment strategy and overall fund allocation.