- If you sell taxable holdings that have fallen, you can book the loss. You can use that loss to offset capital gains elsewhere in your portfolio.
- Two things should line up before converting traditional IRA assets to a Roth IRA—a depressed balance and a low tax year.
- Use qualified charitable distributions, or QCDs, to steer part of your IRA to charity.
Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar. Both stocks and bonds have struggled so far this year, but there might be a silver lining. You may be able to find a way to lower the taxes due on your portfolio. Joining me to discuss three tax strategies for a bear market is Christine Benz. Christine is Morningstar's director of personal finance and retirement planning.
Nice to see you, Christine.
Christine Benz: Good to see you, Susan.
Tax Strategy #1: Consider Tax-Loss Selling
Dziubinski: Christine, let's start out with a strategy that's generally pretty popular during down markets, and that's tax-loss selling. Why can the strategy be beneficial? And where should investors be looking if they want to try to find some candidates for tax-loss selling?
Benz: Right. This strategy can be is super beneficial if you have taxable holdings that have fallen in value since you purchased them, so they're trading below your cost basis. If you sell them, you can book the loss and you can use that loss to offset capital gains elsewhere in your portfolio. If you don't have capital gains, you can use them to offset up to $3,000 in ordinary income. And you can also carry those losses forward. If you don't have a need for them in 2022 but nonetheless want to sell some depressed securities from your taxable account, you can carry them over, carry those losses over into future tax years. So, it's a super effective strategy. I think a great use case for tax-loss selling is if you have highly appreciated securities elsewhere in your portfolio that you know you should reduce but you have been worried about the tax bill in cutting them back, having those tax losses can provide a good way to offset those gains. So, you can do some portfolio maintenance at the same time you engage in tax loss selling.
In terms of where to look for tax-loss sale candidates, the obvious places, the things that have fallen the most in 2022, so stocks, especially growth-oriented stocks that whole growth column of our mutual fund style box would be a place to look. The technology sector, to the extent that you have technology sector funds, or individual technology stocks; cryptocurrency, to the extent that you were late to the party and were dabbling in cryptocurrencies, those might also be candidates for tax-loss selling.
Dziubinski: And then, Christine, what are the rules around then rebuying those same securities?
Benz: Well, that's the rub, and that's called the wash-sale rule, which basically says that you can't turn around and rebuy the same security or what the IRS calls a substantially identical security without essentially negating the tax loss. So, you do need to be careful. There are some workarounds, though. An example is, maybe you had an actively managed large-cap growth fund in your portfolio that you want to cut, you could swap into a large-cap-growth-oriented exchange-traded fund, an index-tracking fund. So, there is a little bit of art to it, but there is a way to circumvent the wash-sale rule while maintaining economic exposure to a similar part of the market.
Tax Strategy #2: Convert Traditional IRA Assets to Roth IRAs
Dziubinski: A second strategy for investors to consider would be converting traditional IRA assets to Roth IRAs. Why is that a good bear-market strategy to pursue?
Benz: Well, for one thing, your balance is probably depressed, assuming you didn't have energy stocks in your portfolio or something like that. And when you're doing conversions, you really are looking for two key things to line up. One is that your balance is depressed, while we have that for most people, and then another thing you want to be looking for is that you personally are in a low tax year for one reason or another. Your income is low, or maybe you have a lot of deductions. If those things line up, that would tend to be a particularly ripe environment for doing conversions. For a lot of people, just one of those things will be the case where their balance will be depressed. So, I think it's really important to get some advice from a tax advisor to find out whether perhaps you can convert just enough of that traditional IRA to a Roth to avoid or to reduce the taxes due upon the conversion. And I should say that the key reason that you'd even want to consider doing a conversion in a market environment like this is that it can potentially lower the taxes due upon that conversion.
Tax Strategy #3: Use Qualified Charitable Distributions to Give to Charity
Dziubinski: And then, lastly, Christine, what about for investors who have to take required minimum distributions, or RMDs? Are there any sort of tax strategies that they should be considering in a market like this?
Benz: One evergreen strategy, not necessarily a bear-market strategy or a down-market strategy is to look at qualified charitable distributions, the QCD, where you are steering a portion of your IRA, up to $100,000, to the charity or charities of your choice. Those contributions are not taxable. So, that's just a great strategy to consider year in and year out. One interesting thing is that the age limit for that QCD is 70.5; it's not 72, as is the case for required minimum distributions. So, you can potentially get that started even before you're subject to required minimum distributions.
Another strategy I would call out, Susan, and it's not one that will lower your tax bill but one that might make you feel a little better about the positioning of your portfolio, is taking an in-kind distribution for your required minimum distribution. So, if there are securities in your portfolio that you don't want to disrupt that you want to continue hold, you can transfer them to a taxable brokerage account through what's called an in-kind distribution. That will satisfy your required minimum distribution. Your tax bill will be the same, but you can maintain exposure to those categories that maybe you wanted to hang on to. So, that's something worth exploring in this environment where many people have securities in their portfolios that they would like to continue to hold as a portion of that portfolio.
Dziubinski: Well, Christine, thank you for your time today and for these tax strategies in a down market. We appreciate it.
Benz: Thank you so much, Susan.
Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.