Can the market losses be utilized to adjust tax payment?

by Mounica Kota | Jun 5, 2020 | capital losses, stock market, Tax Deduction, Tax Rules

Can the market losses be utilized to adjust tax payment?

Losses incurred in the stock market can be termed as Capital Losses. Capital Losses are said to be incurred when a capital asset such as an investment or a real estate decreases in its value. When this capital asset is sold at a price which is much lower than the actual purchase price of the asset, then the capital loss is realized. There are always fluctuations in the stock market and your investments might give you huge profits or even bring your losses. Losses are always demotivating; however, you can note that capital losses can be used to reduce the income tax bill which you owe to pay to the IRS.

Tax Rules related to Capital losses

Like it is mandatory to report Capital gains as income, similarly, Capital losses can be used as deductions on your tax returns.

Capital losses are mainly of three categories which are listed below.

Realized Capital Loss – Realized capital loss occurs after you have sold your asset or investment.
Unrealized Capital Loss – These losses are those capital losses which do not need to be reported.
Recognizable Loss – Recognizable loss is defined as the amount of loss that can be declared in a given year.

According to the US Tax laws, your realized capital losses can have an impact on your income tax bill. Moreover, realized capital losses can be used for lowering the income tax bill only if the asset you have sold was owned for investment. Also, you need to think wisely and create realized capital loss; for instance, if you sell a coin collection for a price lower than its cost price intending to utilize it as a deduction on income tax bill it would not be acceptable.

Determination of Capital Loss

For calculation related to income tax purposes,
Amount of capital loss = Number of shares sold, times the pre-share adjusted cost basis – the total sale price.
Cost Basis price refers to the fact that it provides the basis from which any capital gains or capital losses are figured, of the stock share, is the total of the purchase price and any fees(such as any commission or brokerage fees).
There is a need to adjust the cost basis price if there was a stock split during the period you had owned the stock. You will have to adjust the cost basis concerning the magnitude of the stock split.

Deduction of Capital Losses

Capital losses can be used to offset the capital gains in a taxable year. By this, you would be able in the removal of some portion of your income from your tax return.
A capital loss can be used by you to offset your ordinary income but up to a limit of $3000 in a year in case of a lack of capital gains by which you would have been able to offset your capital losses.
If you are willing to deduct your stock market losses, then you would have to fill Form 8949 and Schedule D while filing tax returns.
Your short term capital losses would be calculated against your short term capital gains by using Part I of Form 8949 to arrive at the net short term capital gain or loss. In case of a lack of capital gains for that year, the net would be a negative number equal to the total of your short-term capital losses.
Part II of Form 8949 will be used for the calculation of your net long term capital gain or loss. It would be equal to any long term capital losses minus long-term capital gains.
The next step is the calculation of the total net capital gain or loss by a combination of your short-term capital gain/loss and the long-term capital gain/loss. The resulting figure would be entered into Schedule D Form.
If your net figure obtained is a negative number (the difference between short term and long term gains/losses) which indicates an overall capital loss then this loss is deductible from any other taxable income with a limit on the amount set by the IRS.
For taxpayers, filing tax returns as Married and filing jointly the maximum amount deductible from total income is $3000. However, for taxpayers filing tax returns as Single or Married and filing separately the maximum deduction permissible is $1500. Moreover, if the amount of your net capital loss is more than the permissible limit you can carry it forward for the next taxable year.

Hence, you must attempt to take your tax-deductible capital losses in a very tax-efficient manner to have maximum benefit. Choosing a short-term capital loss for tax deduction would be more advantageous than that of a long-term capital loss. In general, you should opt for taking any capital loss in the year in which you are tax-liable for short-term gains or in which you have obtained zero capital gains as this would help in saving on your ordinary income tax rate.

References

https://www.investopedia.com/articles/investing/062713/capital-losses-and-tax.asp

https://www.investopedia.com/articles/personal-finance/100515/heres-how-deduct-your-stock-losses-your-tax-bill.asp#:~:text=Deducting%20Capital%20Losses&text=If%20you%20don’t%20have%20capital%20gains%20to%20offset%20the,forward%20to%20future%20tax%20years.)

COVID-19 and Stock Market: How will it affect next year taxation?

by Mounica Kota | Apr 18, 2020 | capital gains taxation, COVID - 19, stock market

COVID-19 and Stock Market: How will it affect next year taxation?

The pandemic COVID-19 has created great havoc in the physical and economic lives of people across the world. In the US, COVID-19 has not only affected the lives of people but also has created a huge amount of economic disruption. Several businesses have been closed temporarily whereas many small businesses might not even be able to open anymore. Many employees are losing their jobs and the overall economy is being affected.

The impact of the pandemic has also been experienced in the global stock markets by recent slides and low values. In the current times, we are in the middle of a pandemic and we have never been prepared for this by the financial markets or by the investment books.

In such tough times, we must be prepared by taking some precautionary steps.

You must check your investment portfolio thoroughly and understand in detail about the stocks in which you have made the investments. You should also understand how investments have been done in these stocks so that you would be ready.
A risk assessment must be done to understand the major risk areas of investment and steps to deal with them.
Investments must be arranged in different kitties so that recovery can also be easy and quick.

However, even during these grim times when the stock market rates are falling steeply, some hand-picked options would help in keeping your finances stable for next year’s taxes.

a.Capital Gains

In simple terms, capital gains are the profits that are earned due to the sale of a capital asset such as a stock, bond or real estate. It is when you are selling an investment such as a stock for an amount which is more than you have paid to purchase it.

Capital Gains are taxed and this taxation depends upon your income. The maximum percentage for taxation of the Capital Gains can be around 20% of your income which can add up to be a huge amount on your tax bill. So, if you are having a loss in your investment you can it can be helpful in reducing your tax bill of Capital Gains. This can help you in keeping an additional amount of money with yourself when the stock markets are down.

b.Loss realization for Capital gains in 2020

Throughout the world, investment owners are experiencing the value of the majority of their investments going down. When fluctuations occur on the Stock board they are known to be paper gains or paper losses. It means that you were just having an observation of the market without taking any action to sell your stocks/bonds.

However, it is quite obvious that market fluctuations would not only be your sole reason to reduce your Capital gains or offset your taxable income. In order to be able to claim the losses incurred in your investments, you should be able to realize the losses. Here the act of realization of losses in an investment indicates the act of selling the investments.

If you are willing to obtain a reduction in your income which is taxable for the year 2020, you must sell those investments on which you had paper losses in the year 2020. Hence, the investments would sell for an amount which is less than the amount at which those investments were bought.

c.Retirement Accounts

Usually, the value of your IRA or 401(k) will not affect your taxes. The traditional IRAs and the 401(k) plans are said to be funded by the help of pre-tax income. According to the Federal Government, these can be considered as ‘paper’ income.

However, if you have a Roth IRA then your taxes would be affected by it. In case there is a loss of value for your Roth IRA hen you would be able to claim that loss on your taxes. But, if you wish to claim your Roth IRA loss on taxes then you will have to close any similar IRAs which you already have.

The theory of Stock Market Recovery

However, amidst all these precautionary measures and preparations to stabilize finances, one thing which must be kept in mind is that the current market situations will turn around in the upcoming few months. Currently, market losses and its impacts are being experienced worldwide and in such scenarios, it would be wiser to evaluate your risks and your investments as well.

Hence, if you have been able to push through your paper losses during market fluctuations you would be able to have much higher capital gains once the market bounces back.