The first bear market in a long time offers an opportunity to dust off an effective tax reduction strategy. Use this strategy now and you could significantly increase this year’s after-tax returns.
The strategy is called a tax swap or mutual fund swap. It works with stocks, bonds, or mutual funds
Suppose you bought some shares near the market top, and they now are showing paper losses. Let’s say you bought Invesco Technology in early March at its peak of $119.53 per share. Now those shares are selling around $75.00. We’re long-term investors, and I expect the technology stocks will be higher within a year.
But for now you can sell Invesco Technology and buy another technology or growth fund, such as White Oak Growth, Price Science and Technology, or Firsthand Technology. The sale gives you a capital loss this year to offset an equal amount of capital gains, perhaps making it easier to take some gains in your Managed Portfolio later in the year. Losses that exceed your gains can offset up to $3,000 of other income on your tax return. Any losses that exceed your gains plus $3,000 can be carried forward to use in future years.
A $3,000 capital loss that offsets long-term capital gains saves you $600 in taxes. A $3,000 capital loss that is deducted from other income in the 39.6% tax bracket saves you $1,188 in taxes. That’s not a bad return for spending a few minutes switching money from one mutual fund to another.
Here’s a catch to beware of. You cannot sell the investment and immediately re-purchase a substantially similar investment and still deduct the loss this year. That means you cannot sell a stock or fund and buy back the same fund or stock. You have to wait more than 30 days. But you can sell a fund and buy another of the same type or investment style. For example, sell a technology fund and buy another technology fund at a different fund family. Or sell a computer software stock and buy a different computer software stock.