Despite recent volatility, it's been a pretty strong year for the stock market. And at this point, you may be sitting on gains in your portfolio, at least on paper. If you're eager to sell some stocks at a profit and make those gains official, you should know that doing so could raise your tax bill significantly.
Whenever you sell investments at a profit, you're required to pay capital gains taxes, the amount of which will hinge on how long you hold those stocks prior to unloading them. If you keep your stocks for a year or less before selling them, you'll be subject to short-term capital gains, which are taxed the same way as ordinary income. If you hold your stocks for at least a year and a day before selling, you'll be bumped into the more favorable long-term capital gains category.
But either way, capital gains could cause you to owe the IRS quite a bit of money. And so if you're looking at a big profit this year, there's one move it pays to make.
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Unload losing stocks before the end of the year
Your goal as an investor is no doubt to buy stocks that make you money. But sometimes, that doesn't happen.
When you get stuck holding stocks that are underperforming, sometimes, selling them at a loss is your best option. But the good news is that taking a loss in your portfolio is a great way to minimize the hit of capital gains taxes.
Say you're sitting on $10,000 in capital gains this year. If you take a $10,000 loss in your portfolio, you'll cancel out the capital gains taxes you owe. And, just as importantly, you'll free up money you can use to invest in different stocks -- ones that may perform much better or lend to more diversity in your portfolio.
Now you may end up with capital losses that exceed your gains for the year. But that's OK, because you can use some of that excess loss to offset ordinary income -- up to $3,000 worth, in fact.
So, say you take a $10,000 loss in your portfolio but you only have a $7,000 gain this year. In that case, you'll still get to use your entire loss for the current tax year.
But even if that's not the case -- say, you have a $10,000 loss and only a $6,000 gain -- you can carry the remainder of your loss into future tax years and use it to offset your tax bill at the time. So for example, in this scenario, you'd carry $1,000 of your loss into 2022 and potentially use it then.
Sell strategically
Making money on stocks is a good thing, but only if it doesn't cause a huge tax crunch for you. If you've profited nicely in 2021, it pays to see if there are losing stocks in your portfolio worth selling. Doing so could really help minimize this year's tax burden, not to mention set you up with more money to invest with in 2022.
