Year-End Tax Planning Tips for Investors

Savvy investors know that taxes can have a big impact on their returns. And while tax considerations should generally take a back seat to sound investment strategies, as you review your investment options think about moves that can slash your tax bill. Here are a few ideas to consider as we approach the end of 2022.

Harvest losses (or gains)

Before year’s end, take inventory of the capital gains and losses you’ve recognized so far. If you expect to end the year with a net capital gain, consider “harvesting” losses by selling some investments that have declined in value and using those losses to offset the gain and reduce your taxable income.

What if you expect to end the year with a net capital loss? In that case, you might consider harvesting some gains from which the loss can be deducted. This strategy enables you to sell one or more investments that have appreciated in value without triggering capital gains tax.

You should, however, avoid offsetting your entire net capital loss. Why? Because you can use up to $3,000 in net capital loss to offset ordinary income, such as salary or interest ($1,500 if married filing separately). Any excess is carried forward and deducted from capital gains or ordinary income (up to the applicable limit) in future years. So, if you harvest gains to offset a net capital loss, try to preserve $3,000 of that loss to offset ordinary income, which is generally taxed at higher rates than capital gains.

Beware the wash sale rule

If you harvest losses or gains, you may be tempted to immediately buy back the investment to keep your portfolio’s asset allocation intact. That way, you enjoy the tax benefits of recognizing the loss or gain without actually giving up the investment. This can be an effective strategy, but be sure to plan carefully to avoid violating the “wash sale” rule.

Under the rule, if you sell a stock or other security at a loss and purchase a substantially identical security within 30 days before or after the sale, the loss deduction is disallowed. To avoid this result, wait at least 31 days before you buy back the investment (though an unexpected price increase can wipe out the tax benefits). Or buy an investment that’s similar, but not substantially identical. Keep in mind that the wash sale rule applies only to investments sold at a loss, not to those sold at a gain.

Donate appreciated assets to charity

If you’re charitably inclined, consider donating long-term appreciated assets — such as stocks, bonds or real estate you’ve held for more than one year — to charity. You’ll avoid tax on the gains you would have realized had you sold the assets, while enjoying a charitable deduction equal to the assets’ fair market value (subject to certain limitations and assuming you itemize deductions).

Avoid year-end mutual fund investments

Mutual funds typically distribute accumulated dividends and capital gains near the end of the year. There’s a common misconception that investing in a fund just before a distribution gives you access to free money.

On the contrary, because the value of your shares is immediately reduced by the amount of the distribution, you’ll essentially pay income tax on the distribution without receiving any benefit. If you instead invest after the distribution, you’ll be in the same financial position, but without the added tax liability.

Maximize contributions to traditional IRAs and retirement plans

If you haven’t maxed out your deductible or pretax contributions to traditional IRAs, 401(k) plans or other tax-advantaged retirement accounts, don’t miss this opportunity to reduce this year’s taxable income while building your nest egg. Far too many taxpayers fail to take advantage of their annual retirement contribution limits and miss out on reducing their taxable income.

Contributions to 401(k)s or similar employer plans generally must be made by December 31. But you can take a 2022 deduction for traditional IRA contributions made as late as April 18, 2023.

Strike a balance

Effective financial planning requires a balanced approach that considers both tax efficiency and sound investment principles. Your tax and investment advisors can help you strike a balance between the two.

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