Get A Bigger Tax Refund With A Stock-Selling Trick You Might Not Know About

With the end of the year comes the sometimes arduous task of filing your annual income tax return. Unfortunately, that includes taxes on any shares of stock, ETFs, or other investments that you sold at a profit. At the time of writing, the benchmark S&P 500 index is up approximately 26% year-to-date, while the blue chip Dow Jones index has rallied more than 18%. Therefore, odds are that you'll owe Uncle Sam if you cashed out during this epic rally.

To be clear, assets that are sold at a higher price than was originally paid have experienced a capital gain, which is a taxable event. The IRS has two different sets of rates for capital gains tax: short term and long. Like the name implies, long-term capital gains tax applies to assets which have been held for longer than one year (even just one year plus one day). Long-term capital gains are taxed at a lower rate than regular income tax. For 2024, the long-term rates are either 0%, 15%, or 20% depending on how much other taxable income you have. 

Assets or investments held for one year or less are subject to short-term capital gains tax rates, which are exactly the same as regular income tax. However, what if not all of your investment picks were successful? If you're been sitting on a few stock market losers, the end of the year might be the perfect time to sell to reduce your tax burden on the winners.

In investing, selling failing investments at a loss in order to reduce — or even eliminate — your tax exposure on profitable transactions is known as "tax-loss harvesting." Of course, this concept only applies to taxable accounts like a brokerage account, not retirement accounts such as IRAs or 401(k)s which are tax sheltered. Investments in those types of accounts can be bought and sold at will without tax consequences so long as the funds remain within the accounts until the proper age for withdrawals is reached, with exceptions for extenuating circumstances.

For example, if you realized a gain of $20,000 on investment A, which was held for 300 days, but lost $8,000 on investment B, which you owned for a period of 200 days, that translates into paying capital gains on just $12,000 rather than the full $20,000 profit from investment A. You can determine if the new 2025 tax brackets will affect you personally, but assuming that an investor is in the 22% income tax bracket, that's a savings of $1,760 ($8,000 x 0.22).

If you were particularly unlucky and your losing investments outnumbered your winners, you're allowed to deduct up to $3,000 in investment losses from your regular earned income. If your investing loss is greater than $3,000, that loss can be carried forward to future tax years until it's exhausted. However, before you purge your brokerage account of every losing position, there are a few considerations to keep in mind.

In the rush to minimize your tax obligations, don't forget that the whole point of investing in the stock market — whether through individual shares or ETFs — is long-term capital growth. Short-term volatility and price fluctuations are to be expected and will typically moderate over a longer period of time. Unless you're an active trader, getting overzealous about selling your losing position for a small tax benefit could be viewed as a bad move in future years, so consider carefully.

If you do decide to engage in tax loss harvesting to garner a bigger tax refund, be sure to make your moves by December 31. Unlike some other investing tasks that can be completed up until the tax-filing deadline — like contributing to a retirement account — tax-loss harvesting must be complete by the end of the calendar year. Finally, you'll want to be cautious of repurchasing an exact or even a "substantially similar" investment within 30 days before or after your tax loss sale. Otherwise, the IRS may disallow the loss. 

If you've truly lost confidence in one or more investments that have declined in value since purchasing, selling them to offset your profitable transactions can reduce your income tax exposure and possibly even result in a larger refund. However, knowing when to sell a stock is complicated. As always, Money Digest recommends consulting with a financial advisor or tax preparation expert to reinforce your decision.