Question: I was heavily invested in the company I helped startup, and let personal feeling get the better of me. After about 10yrs there, the company went Ch.11 this year and I was left holding the bag (a lot of RSUs and ESPPs).
Long story short, I want to find the best strategy for leveraging the nearly $100k in capital loss this represents.
Coincidentally, I have a bit over $100k in unrealized gains (long term, 15%) in FAANG stocks in a taxable brokerage that I've been think of selling and swapping for VOO or VT. Should I just use this as the opportunity to realize those gains, and call it a wash?
Alternatively, should I offset $3k of ordinary income (24% tax bracket) for the next 33yrs?
Are there other strategies that I should consider?
Answer:
Maximizing the Benefit of Your Capital Loss
I'm sorry to hear about your company's bankruptcy and the financial impact it has had on you. Dealing with a significant capital loss can be challenging, but there are strategies to leverage this loss to your advantage. Let's explore your options:
Understanding Capital Losses and Gains
- Capital Losses: These occur when you sell an asset for less than your cost basis. The IRS allows you to use capital losses to offset capital gains and a limited amount of ordinary income.
- Capital Gains: Profits from the sale of assets held for investment purposes. Long-term capital gains (assets held for more than one year) are taxed at preferential rates (0%, 15%, or 20%) depending on your taxable income.
Option 1: Realize Capital Gains Now to Offset Losses
Strategy: Sell your FAANG stocks to realize approximately $100,000 in long-term capital gains, which can be offset by your $100,000 capital loss, effectively eliminating the tax liability on these gains.
Pros:
- Tax Efficiency: Offsetting $100,000 of gains means you avoid paying the 15% long-term capital gains tax, saving you up to $15,000 in taxes.
- Portfolio Diversification: Swapping individual stocks for diversified index funds like VOO (S&P 500) or VT (Total World Stock ETF) reduces company-specific risk.
- Simplification: Moving to index funds can simplify portfolio management.
Cons:
- Opportunity Cost: If FAANG stocks continue to perform well, you may miss out on future gains.
- Transaction Costs: Potential brokerage fees or commissions from selling and buying securities.
- Timing Risk: Market conditions could affect the price at which you sell your stocks.
Considerations:
- Wash Sale Rule: This rule doesn't apply when selling gains, but be mindful if you're repurchasing similar securities.
- Market Outlook: Evaluate whether now is a good time to sell your FAANG stocks based on their performance and market conditions.
Option 2: Offset Ordinary Income Over Time
Strategy: Use the capital loss to offset up to $3,000 of ordinary income each year, carrying forward the unused loss indefinitely.
Pros:
- Tax Reduction on Ordinary Income: At a 24% tax bracket, you save $720 annually ($3,000 × 24%).
- Retain Investments: Keep your FAANG stocks, potentially benefiting from future appreciation.
- Flexibility: The unused capital loss carries forward indefinitely until fully utilized.
Cons:
- Extended Time Frame: It would take over 33 years to fully utilize the $100,000 loss, considering the annual $3,000 limit.
- Present Value of Money: Due to inflation and time value of money, future tax savings are worth less in today's dollars.
- Opportunity Cost of Tax Savings: Immediate tax savings from offsetting capital gains might be more beneficial.
Considerations:
- Life Changes: Future income changes, tax law adjustments, or personal circumstances might affect the benefit of this strategy.
- Inflation Impact: The real value of $3,000 decreases over time due to inflation.
Option 3: A Hybrid Approach
Strategy: Partially realize capital gains to offset some of the loss now and use the remainder to offset ordinary income over time.
Pros:
- Balanced Benefits: Capture immediate tax savings while retaining some FAANG stocks.
- Flexibility: Adjust the amount of gains realized based on your tax situation and market conditions.
Cons:
- Complexity: Requires careful planning to optimize tax benefits.
- Partial Deferral: You still face the extended time frame to utilize remaining losses against ordinary income.
Option 4: Harvest Gains from Other Investments
Strategy: Review your entire investment portfolio for other assets with unrealized gains that you could sell to offset the capital loss.
Pros:
- Comprehensive Tax Planning: Maximize the use of your capital loss across various assets.
- Portfolio Rebalancing: Opportunity to adjust your asset allocation according to your risk tolerance and investment goals.
Cons:
- Transaction Costs: Selling and buying assets may incur fees.
- Market Impact: Market conditions may not be favorable for selling certain assets.
Option 5: Consider Future Income and Tax Scenarios
Strategy: If you anticipate higher income or entering a higher tax bracket in the future, preserving the capital loss to offset higher-taxed income might be advantageous.
Pros:
- Potential for Greater Tax Savings: Offsetting income taxed at a higher rate increases your tax savings.
- Strategic Timing: Aligns tax benefits with periods when they are most valuable.
Cons:
- Uncertainty: Future income and tax rates are not guaranteed.
- Delayed Benefit: You postpone tax savings that could be realized now.
Option 6: Engage in Tax-Efficient Charitable Giving
Strategy: If you're charitably inclined, consider donating appreciated securities directly to charities.
Pros:
- Tax Deduction: You may receive a tax deduction for the fair market value of the donated securities.
- Avoid Capital Gains Tax: Donating appreciated assets allows you to avoid paying capital gains tax on those assets.
- Utilize Capital Losses Elsewhere: You can still use your capital losses to offset other gains or income.
Cons:
- Itemized Deductions Needed: To benefit, you must itemize deductions on your tax return.
- AGI Limits: Deduction amounts may be limited based on a percentage of your adjusted gross income.
- No Direct Offset: This doesn't directly use your capital losses but can be part of an overall tax strategy.
Additional Considerations
- Tax Law Changes: Be aware that tax laws can change, potentially affecting future benefits of carrying forward losses.
- State Taxes: Consider state income tax implications, as they may differ from federal tax rules.
- Professional Advice: Given the complexity and potential financial impact, consulting a tax professional or financial advisor is highly recommended.
Recommendations
Evaluate Immediate vs. Future Tax Benefits:
- Immediate Benefits: Offsetting capital gains now could provide substantial tax savings today.
- Future Benefits: Offsetting ordinary income provides smaller annual tax savings over a long period.
Assess Your Investment Goals:
- Diversification Needs: If your portfolio is heavily weighted in FAANG stocks, selling to diversify could reduce risk.
- Market Outlook: Consider the growth potential of your current holdings versus index funds like VOO or VT.
Consider Partial Realization:
- Sell a Portion of FAANG Stocks: Offset some gains now and retain some positions for future growth.
- Staggered Sales: Spread sales over multiple tax years to manage tax brackets and market timing.
Consult a Professional:
- Tax Professional: Can provide personalized advice considering your entire financial picture.
- Financial Advisor: Can help align your tax strategy with your long-term investment goals.
Conclusion
Leveraging your $100,000 capital loss effectively depends on your current financial needs, future income expectations, investment goals, and risk tolerance. Realizing gains now to offset losses can offer significant immediate tax benefits and an opportunity to rebalance your portfolio. Alternatively, carrying forward the loss to offset ordinary income provides smaller annual benefits but preserves your current investments.