The natural follow-up to: Buy Low. Sometimes High.   

 

While I have the Yin-Yang thing going on with the titles of these article, the premises are different.  With buying, the only way to know whether you’ve made a good purchase is to know the future price, which isn’t possible.  With selling, you know whether the price increased or decreased since you when you bought it.  

 

When you decide to sell a fund, there are tax implications, sometimes good, sometimes bad…

 

Selling High

 

If you listen to the mantra and “sell high,” you’ll have to pay capital gains tax on the difference.   So if you bought something for $40 and now the value is $100, you’ll have to pay taxes on the $60 you earned.  The tax rate at which you pay is then determined by how long you held that fund:

  • Short-term capital gains: for any investment owned <1 yr, any gain in value is taxed at your current tax rate.
  • Long-term capital gains: for any investment owned >1 yr, any gain in value is taxed  at a lower rate, still based on your tax bracket, but only up to 20%.

 

So even though it may seem like your brilliant pick netted you an extra $60 in your piggy bank, you won’t be taking home 100% of that.  But hey, you’ve still made money, nice!  

 

 

Selling Low

 

There are two main reasons you’d probably want to sell a fund when you’ve lost money on it:

  • You’re cutting your losses- maybe you feel the fund will lose more of its value if you wait any longer.  Perhaps you no longer believe in the company.  Maybe they set up a bunch of fake banking accounts and morally you feel that you can no longer be a shareholder.  
  • You want to get a tax break on the losses- the IRS code is not always fair, but in this case, since you pay taxes on gains, they give you a break any losses.  This is also known as Tax Loss Harvesting (TLH)…it’s kind of a big deal these days. 

No matter the reason, if you suffered a loss, you can get a tax break for that loss.  Say you bought a fund at $100 then the price fell to $60.  If you sell the fund, you’ll realize a $40 loss, which can then be used to offset taxable income for that year.

 

 

Tax Loss Harvesting

 

To really benefit from tax loss harvesting, you will take the loss, pocket the tax break then reinvest in another fund similar to the one you just sold.  This allows you maintain exposure to a similar mix of stocks because you are betting on them to eventually gain in price.  What goes down, must go up, right?  Well, maybe not with physics, but certainly possible with the stock market.

 

The big thing you need to watch out for is that the new fund is not the same or even “substantially identical” to the one you just sold at a loss.  This is known as a “wash sale,” and is frowned upon by the IRS (discussed below).  Basically you can’t sell Guggenheim Equal Weight S&P 500 and then buy iShares Equal Weight S&P 500, they are substantially identical.  I mean, you can do this, but you couldn’t take the tax break from the loss. Two S&P 500 funds with similar proportions of their holdings would probably meet the “substantially identical” criteria.

 

 However, if you sell an S&P 500 fund and buy a Total Stock Market fund, you’d be in the clear.  They are different enough to avoid the “wash sale rule,” but similar enough that you maintain exposure to a good selection of US funds. 

 

Another option you have, though I’d only recommend this under specific conditions,  is to just wait 30 days after you sell a stock at a loss before buying that same stock again.  When would I recommend keeping money on the sidelines for 30 days?  If the stock price continues to decline even after you thought it hit it’s bottom.  As long as it’s trending down, no need to make a hasty purchase.  

 

Wash-Sale Rule

 

Within 30 days of selling a fund for a loss, you cannot purchase the same fund or a “substantially identical fund”

  • Applies across all accounts you own- you can’t take the tax benefit in one account and then buy the same fund in another account including retirement accounts
  • Applies to reinvested dividends as well- if you sell a portion of a fund, or even if you sell the whole fund, but have an substantially identical fund in another account, the wash-sale rule is in effect (doesn’t negate your entire harvest, just lowers the harvest value by the value of the dividend). 
  • Limitations- Can only realize up to $3,000 ($1,500 if single) toward earned income.  Anything beyond that offsets capital gains earnings.

 

 

Obviously you’d ideally buy a fund when it’s low and then turn around and sell that fund when it’s high.  Sometimes though, it’s okay to sell low and reap some of the benefits discussed above to ease those losses. Basically this is all a big game.  The IRS code is the rule book and it’s up to you to strategize a winning game-plan while staying within the rules.  Unless you’re a Russian athlete, apparently rules don’t apply. 

 

 

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