Use it or lose it | Jobs Vox


Deducting tax on your investments is getting easier. Politicians who like to “close loopholes” take notice.

There is still time. You have two weeks left to take capital losses using your 2022 tax bill to cut your bill.

This is a use-it-or-lose-it proposition. It’s not just that the end of the tax year is approaching. I think the whole system of debt collection is at stake. It is easy prey for the next “tax reform” – not this year or next disaster, but certainly something that can be implemented in 2026.

Loss harvesting means divesting losers of stocks, bonds, and funds. You sell it and immediately replace it with something similar but not the same. A resulting capital loss can include any amount of capital gain and up to $3,000 of ordinary income, such as wages or interest. The remainder of the loss can be carried forward, indefinitely, into future tax years.

We are talking about assets in taxable accounts. If you have money in tax-deferred retirement accounts, it’s not appropriate to collect it.

I have been plugging the bankruptcy claim strategy for four decades. It still works. But now I’m worried that Congress will take it away or at least make other changes that will lower the price of the harvest.

Not long ago, harvesting was the game of the savvy few and the very wealthy thrift. A person with a $100 million portfolio sells $1 million of Treasury bonds at a $100,000 loss and immediately puts $900,000 into Treasurys with the same economics but a slightly different coupon or maturity date.

Then came automatic programs for the rich only. Aperio, now part of BlackRock, and Parametric, now part of Morgan Stanley, developed software for computerized portfolios that automatically rotate hundreds of stock positions.

And now the masses are overwhelmed by low-cost automated portfolios from companies like Betterment, Wealthfront and Fidelity for as little as $5,000. Fractional shares and zero commissions enable the type of accumulation once only possible for the wealthy.

Computerized Aggregation Fee: As much as 0.25% of the account per year paid to an online brokerage firm or typical retail money management fee to the custodial service provider.

The computers get their bearings. A tax benefit of 1% of assets per year in the early years of the strategy is very possible, although the savings are highly dependent on what happens elsewhere on your tax return. If you are putting new money into the account, if the markets are volatile, and if you have or will soon have capital from other places, you can get the most out of it.

Most computerized asset swings fall into the “direct indexing” category, as the objective is to track a stock index such as the S&P 500. A robot that runs the portfolio, for example, could take a loss on 22.3 shares of ExxonMobil. Invest the money in 17.8 shares of Chevron and return after 31 days. If you buy back a security within 30 days of selling it, it’s a violation of the wash-sale law, which carries capital losses.

I’m afraid the crop is becoming too popular. Matt Belknap, who tracks the retail money management industry at Cerulli Associates, predicts direct indexing will reach $800 billion in four years, boosting mutual funds, exchange-traded funds and individually managed accounts.

Some of this direct indexing serves other purposes (such as tailoring an investor’s socially responsible investment objectives). But most of it has a tax angle. Belnap estimates that 90% of direct indexing takes place in tax bills.

The loss claim is especially powerful when combined with three classic tax dodges, allowing you to dispose of valuable assets without realizing a gain. So, you have a computer, buy 300 shares, and later sell 50 losers for cash to get capital loss deductions. 250 winners have been wisely eliminated.

First elimination method for the winner: Donate to charity after holding the position for at least one year. The next trick: give a relative to a low bracket, sell at a low or zero tax rate. Third: When heirs destroy your estate, take it to the grave so that there is no taxable profit.

Can tax reformers notice that there is something unfair about how portfolios are penalized? Owners of mutual funds pay more taxes than owners of similar portfolios organized as ETFs; This is because ETFs, but not mutual funds, can use swaps with market makers to eliminate taxable appreciation. Owners of ETFs, in turn, pay more taxes than owners of similar portfolios managed by direct index computers; This is because stocks, but ETFs, cannot pass through capital losses.

A flick of the wrist of the Legislature will dispatch some of these tax tyrants. That is, Congress could simply give EFAs the same tax treatment as mutual funds, and could simply decide that a gift appreciated to a relative would be taxed as if the gift had been sold.

It’s a trickier matter to sell smart investors and take broader action to catch winners while catching losers. But it is not beyond the reach of legislators with inequality or a thirst for tax revenue.

Sen. Ron Wyden (D-Oregon) has proposed a tax system in which people who own commercial securities would have to pay a tax on their paper gains each year. At first, the system will only apply to billionaires. But once it starts, will lawmakers be able to extend the millionaires while trying to balance the budget? Or thousands?

Take note: There is a precedent for such a system called a mark-to-market tax. It is already in place for most derivatives and commodity futures. It can be extended.

Now, there may be some complications. There had to be some way to deal with privately held companies that had no market value. That is, Congress is looking for a way to go after Elon Musk over his Twitter findings.

Senator Wyden has a plan. Properties with no public market value would have been taxed, as now, only on sale, but in previous years there would be a surtax designed to eliminate the benefit of tax deferral.

Another messy trade-off has to do with protecting preferred taxpayers (farm or suburban owners) from higher capital gains taxes. Exceptions can be made, but taxpayers must come up with specific exceptions to avoid new deductions.

Another complication is that the Widenesque attack on portfolios would be very destructive to capital formation if not combined with another reform that is meant to help asset owners: asset inflation adjustment. Accounting for inflation-adjusted capital gains is seriously discussed. It can be applied, but it will triple the number of hours you need to complete Schedule D.

For the time being, debt collection works. He will be attacked. A few years later, when the law changes, it affects the methods that savers use to protect their assets from the tax collector. If this happens, it will certainly happen in a way that further extends the tax regime.

Regardless of what you pay your portfolio manager now, you can still pay taxes up front, but to tax accountants.

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