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.
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.
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.
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.
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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?