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Stock Market Loss in 2022? Don't Sweat it — This Tax Strategy Should Help!

Although the goal of investing is to make money, the cards won't always line up in your favor.

Take 2022 for example. The stock market has been on a wild rollercoaster ride, and investors have seen their portfolios drop significantly. Many leading tech companies such as Amazon and PayPal have seen their valuations drop by 40% or more as stocks reach 52-week lows.

If you sold your investments at a loss in 2022, you may be eligible to use a special tax strategy that will help you turn your stock market pain into gains on your tax return. Below, we'll unlock the power of tax-loss harvesting and show you how it works.

Image source: Getty Images.

The 411 on tax-loss harvesting

Before you buy or sell investments, it's important to talk to your financial team of experts to determine the tax implications of your actions. It's also good to get ahead of strategies that can save you money down the line.

For instance, if you sold investments at a loss this year, tax-loss harvesting could be key to reducing your tax bill. This strategy allows you to offset capital gains in your portfolio with any losses you may have incurred during the year. The proceeds from the sales can be used to invest in other stocks that align with your goals, time horizon, and risk tolerance.

Let's say you sold a stock held in your portfolio for over a year at a $10,000 gain. You also sold one of your long-term, beaten-down tech stocks at a $15,000 loss. Since your losses exceed your long-term gains, you don't have to worry about long-term capital gains taxes. You can use the remaining $5,000 loss to offset short-term capital gains. If you don't have any short-term gains, you can use some of your loss to offset your ordinary income. Essentially, tax-loss harvesting allows you to walk away with a lighter tax bill.

There are rules that you need to be aware of if you are considering tax-loss harvesting. If you want to buy a stock that you recently sold, you want to hold tight for about a month, or you'll be up against the wash-sale rule. You could get into trouble with the IRS if you sell a stock, pursue tax loss harvesting, and then try to buy that same stock back within a certain time frame.

Save more money by lowering your ordinary income

Tax-loss harvesting allows you to potentially reduce your capital gains tax all the way down to zero. You may be able to save thousands of dollars during tax time, because a portion or all of your capital losses incurred beyond your capital gains can offset your ordinary income.

Let's say the energy stocks in your portfolio have gained in value by $20,000. On the flip side, your tech stocks have dropped in value by $30,000. You end up selling your energy stocks to realize a taxable gain of $20,000. That gain is offset by a $30,000 capital loss on your tech stocks, which takes your capital gains tax to zero. You have $10,000 in capital losses remaining, and those losses don't have to go to waste.

You can use up to $3,000 of your remaining capital loss to reduce your ordinary income. This can be a victory on your tax return, because marginal federal tax rates on ordinary income can be as high as 37%.

Assuming a 35% marginal tax rate, you could end up scoring a potential tax benefit of over $8,000. Here's how that works:

  • $20,000 capital gain x 35% marginal tax rate = $7,000
  • $3,000 x 35% marginal tax rate = $1,050
  • Total potential tax benefit = $8,050

And that's just the tax savings in the same year. With only $3,000of the total $10,000 in capital losses set to reduce ordinary income, the extra $7,000 can be carried forward to future years.

Turn your tax losses into tax benefits

A stock market loss could make you cringe when you look at your portfolio, but it can be a saving grace on your tax return. Your losses could potentially wipe away all your capital gains taxes and allow you to score tax savings on your 2022 tax return.

Before you sell assets in your portfolio, it's important to weigh the pros and cons. If you're a fan of the underlying businesses in your portfolio and are comfortable with your allocation of assets, you probably shouldn't sell those assets just to snag a tax benefit. But if you're seeking to rebalance your portfolio, free up cash, or take advantage of better opportunities in the market, tax-loss harvesting can make that process more rewarding during tax season.

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