Last month we discussed the importance of asset location. For assets located in taxable brokerage accounts, focusing on after-tax total return, rather than simply total return, can add significant value to your net worth over time. Let’s explore the short- and long-term capital gains rates, qualified dividends, and tax-loss harvesting.

Unlike traditional IRAs, where the saver pays taxes on withdrawals and can trade within the account without tax implications, trades within a taxable brokerage trigger capital gains or losses. For example, if you buy 100 shares of a stock trading at $10 per share, and sell it for $20 per share, you would trigger a capital gain of $1,000. If you held the stock for one year or less, the IRS would tax the $1000 gain at your ordinary income rate. If you held the stock for one year or more, you would pay the far more favorable long-term capital gains rate of 0%, 15%, or 20%, depending on your income level for the year. Unless you have an extremely compelling reason to sell a stock within a year after buying it, try to hold out until day 365.

Not all dividends are created equal. The IRS taxes ordinary dividends (the default for all dividends) at the ordinary income rate. However, if a common stock or mutual fund is held for at least 60 days, and the dividend is paid by an American or qualifying foreign company and is not listed as unqualified by the IRS, then the dividend is “qualified” and taxed at the favorable long term capital gains rate. Make sure your taxable investments pay qualified dividends.

Buy and hold is a fine strategy, but you can add significant value to your after-tax total return by employing a tax loss harvesting strategy in your taxable account. Imagine you bought $50,000 of an SP500 ETF in December 2021. In 2022, you were down about 20% and your investment was only worth $40,000. Rather than just waiting for the market to recover, you could have sold your SP500 ETF, realized the $10,000 loss, and bought something similar like a large-cap mutual fund (but not so similar that you create a wash sale, and kill the strategy) so that when the market recovers, you also participate in the upside.

By harvesting the $10,000 loss, you create a tax asset, which can be used to offset gains in other parts of your portfolio. If you have no other triggered gains, which you wouldn’t if your advisor manages your assets in a tax-aware way, you can deduct up to $3,000 against your income. The remaining $7,000 would carry forward to the next tax year to offset gains or deduct $3,000 against income, and so on. Over time, the $10,000 tax asset is worth $10,000 multiplied by your marginal tax rate, for as much as $3,700 of real dollars in your pocket come April.

Holding investments for at least one year, making sure your portfolio pays you qualified dividends, and harvesting tax losses can all help you save money on taxes and keep more of what you earn. Remember, though, that if you wait for tax season to think about these strategies, you’re too late! Now is the best time to reach out to a financial advisor to optimize your tax strategy.

Tune in next month when we’ll evaluate the relationship between financial planning and investment management!

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