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How to Unlock Tax-Loss Harvesting Strategies for Couples Filing Separately

Toward the end of the year, you might hear the term “tax-loss harvesting.” But what does that mean? And how can you use it as a student loan borrower? 

Learn how this strategy can help you offset some of your investment losses at tax time.

What is tax-loss harvesting?

Tax-loss harvesting reduces your income tax by using some of your investment losses held in taxable accounts to offset a portion of your income. Note that this strategy doesn’t apply to tax-advantaged retirement accounts, like an IRA or 401(k), or a Health Savings Account).

But if you have some losses in your investment portfolio, you can “harvest” them for the tax year — up to a certain amount.

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How tax-loss harvesting works

Using an investment loss to lower your capital gains tax is the crux of the investment strategy known as tax-loss harvesting. Your gains (or losses) are divided according to your investment type. 

You must have realized losses — meaning you actually sold your assets at a loss — to harvest losses. Losses and gains don’t “count” as far as the IRS is concerned if your taxable investment account is down but you haven’t sold any of your investments. How long you’ve held the assets plays a key role in how tax-loss harvesting works:

  • Short-term capital gains (and losses). The total gain or loss on investments you’ve had for a year or less. These gains are taxed as ordinary income in your regular tax bracket.
  • Long-term capital gains (and losses). The total gain or loss on investments you’ve owned for at least a year. Long-term gains are taxed at a special capital gains tax rate of 0%, 15% or 20%, depending on your tax bracket.

First, your losses are matched to your gains. For example, let’s say you sold stock that you only owned for six months for an overall increase — or gain — of $500.

You’d start by selling another stock you’ve owned for less than a year — a short-term capital loss — and perhaps sell it for $600 less than you bought it for. You can use that $600 loss to offset the $500 gain. This tactic avoids paying capital gains taxes, and you’ll still have $100 “left over.”

The same process applies to long-term gains. Long-term losses first offset long-term gains before “passing through” to your income.

Anything leftover after offsetting gains (or if you’ve only sold losing investments) is used to lower your income. This is considered a deduction. Depending on your filing status, you can deduct up to $3,000 in losses from your investments. Anything extra can carry over to future tax years.

For example, if you have $4,000 left after offsetting your investment gains, you can only use $3,000 to reduce your regular income. The remaining $1,000 can be carried forward to offset future investment income or even regular income.

Tax-loss harvesting when married, filing separately

Some married student loan borrowers file their taxes separately, changing how they can use tax loss harvesting to their advantage. For the most part, when harvesting a capital loss, you can only deduct up to $1,500 if you’re married, filing separately. This can reduce how much income you can offset.

Additionally, it’s important to note that if you have a joint brokerage account with your spouse and you file separately, investment income and losses are split between you. You can each get up to $1,500 as a tax deduction, but you need to base it on how you split the results of your taxable account. 

Consult with a tax professional as you run the numbers to see how this affects your tax liability.

Tax-loss harvesting for student loan borrowers

One consideration for student loan borrowers is figuring out how to manage investments for tax purposes while navigating income-driven repayment (IDR) as a married couple.

In some cases, married filing separately makes sense, so you can still qualify for lower monthly payments on an IDR plan. However, depending on the situation, being able to deduct the total $3,000 amount in tax losses might be a better move for your joint tax burden. 

Making this decision requires that you fill out your tax returns both jointly and as single filers to figure out which is the best move for you as a couple.

3 steps to harvest tax losses

In many cases, it’s best to “buy and hold” your investments rather than jump around.  However, sometimes it makes sense to cut your losses and move to a new investment. 

For example, consider if tax-loss harvesting can keep you out of a higher tax bracket for another year or provide a tax break. In that case, it might be worth it — especially if having the investment in your portfolio isn’t vital or it’s time to rebalance your asset allocation.

1. Monitor your investments

Start by looking at investments that have lost value and might no longer serve a purpose in your investment portfolio. Remember, tax-loss harvesting only works for assets in a taxable account.

Additionally, consider that mutual funds (including index mutual funds) don’t often make good candidates for tax-loss harvesting because of their settlement process. Exchange-traded funds (ETFs), individual stocks and even cryptocurrencies might be better for harvesting losses.

2. Sell your investment to make the loss “real”

Next, sell your chosen investment. You can’t “realize” the decline in its value unless it’s sold. In many cases, a broker (including reputable cryptocurrency exchanges) will issue you a form that indicates whether your losses are short- or long-term. This will help you know how to offset any gains you realized earlier in the year.

Later, when filling out your tax return, you’ll use Schedule D to report the situation. After offsetting your taxable gains, you can use the remaining losses to offset your ordinary income.

3. Reinvest your funds in something similar

After selling and realizing the loss, buying something else with the money is possible. However, you must be careful not to buy the same or a “substantially identical” investment within 30 days. This is known as the wash sale rule.

If you sell at a loss, and then immediately buy the same investment, the IRS won’t let you claim the loss on your taxes. You either need to wait 30 days to reinvest in it or choose an investment similar to what you just sold, but not the same one.

Take your tax strategy to the next level

Tax-loss harvesting can help you take your strategy to the next level, especially when used with other tax breaks and your IDR strategy. SLP Wealth tax services can help you test different scenarios and create a plan that works for you.

FAQ: Tax-loss harvesting questions answered

Can you claim capital gains losses married filing separately?

Yes, you can claim capital gains losses, but your tax deduction on regular income is limited to $1,500. Consult with a tax professional, especially if using a joint brokerage account.

Is there a downside to tax-loss harvesting?

When you use tax-loss harvesting, you’re “locking in” losses on the investments sold. Additionally, you can’t repurchase the same investment within 30 days if you want the tax deduction. Consider your overall investment strategy and carefully consider which assets you sell for loss-harvesting purposes.

Why are capital losses limited to $3,000?

In general, the idea is to keep you from accumulating losses to the extent that you are constantly selling investments or always reducing your taxable income to $0. If you have losses that exceed $3,000, you can carry them forward to another year.

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