My 1st Million At 33 - yes, you can do it too

Before the end of year, I’m contemplating what stocks to sell for capital losses to offset my capital gain this year. Here are some of the evaluation & steps that I suggest to take:

1. The maximum loss that one can deduct per year is $3000 (married filing jointly) or $1500 (filing separately). By the way, The US government should really index this number by inflation. It has been this low for so many years.
2. You should try to sell the minimum number of positions, without impacting your overall investing portfolio/direction/philosophy.
3. Don’t fall into wash sale trap, selling the same stock, and buying back within a month.
4. In order to avoid wash sale trap, you can use this opportunity to swap with other technically stronger stocks in the similar sectors. Or you can use sector ETF instead of individual stocks.

Another tax tip that most people don’t pay attention to is the tax rate differences between long term/short term capital gain. Because long term capital gain is taxed at a lower rate, it also means that long term capital loss will offset less tax than short term capital loss (whenever you have some long term capital gain to be offset). Your long term capital loss will be equivalent to short term loss when you don’t have any long term gain, but only losses. In that case, all losses will be deducting against your highest tax bracket income.

Therefore, for tax purpose, you should try to take short term capital loss, while retaining long term capital gain. In principle, the two best scenarios for taxes are to show either a short and/or long term loss without any long term gain, or a long term gain (+ any short term gain but not loss). For example, if you have two stocks A & B. In stock A, you have made $3000, while in stock B, you have lost $3000. If you let them offset each other in the same year, you get $0. If you somehow make the gain to become a long term gain, and take the gain in a different tax year (1/1 and 12/31), you will actually gain some $300 from tax. How so? Take $3000 loss in one year, assuming that you don’t have any long term gain to be offset, then $3000 short or long term loss will be deducting against your highest tax bracket income. Then taking the $3000 long term gain in another year will be taxed at 20%. Assuming your tax bracket is at 28% to 33%, you can gain $240 to $390 in tax difference (after-tax money). A general tax strategy can be that you alternate between showing losses and long term (+short term) capital gain. But obviously, $3000 tax loss is too small of a room to play out such strategy for most people.

In summary, don’t “waste” your long term capital gain by shrinking it with losses. Move the losses to another year. The only exception to this is when you are hitting AMT or alternative minimum tax. But with Congress expanding the AMT deduction, most likely you won’t hit AMT unless your capital gain is above roughly $30000. In that case, you can use my tax calculator to exactly figure out whether you will hit AMT or not.