As the year comes to a close, most people begin thinking about holiday shopping and New Year's resolutions. Smart investors, however, spend a few minutes reviewing their portfolios. A handful of simple decisions made before December 31 can reduce your tax bill and help you build more wealth over time.
Here are three year-end tax strategies every young investor should understand.
1. Consider Tax-Loss Harvesting
If you own an investment that has lost value, selling it before the end of the year may actually benefit you.
This strategy, known as tax-loss harvesting, allows you to use investment losses to offset investment gains. For example, if you made a $2,000 profit selling one stock but lost $1,500 on another, your taxable gain would only be $500.
If your losses exceed your gains, the IRS also allows you to deduct up to $3,000 of net capital losses against your ordinary income each year. Any remaining losses can be carried forward to future tax years.
One important rule to remember is the wash-sale rule. If you sell a stock for a loss and buy the same, or a substantially identical, investment within 30 days before or after the sale, you generally cannot claim that loss for tax purposes. If you still want exposure to the same industry, consider purchasing a similar, but not identical, investment instead.
2. Max Out Your Roth IRA
If you're eligible, contributing to a Roth IRA is one of the best long-term investing decisions you can make.
Unlike a traditional IRA, Roth IRA contributions are made with money you've already paid taxes on. The benefit comes later. Once you reach retirement age, qualified withdrawals, including decades of investment growth, are completely tax-free.
The earlier you begin contributing, the more time your investments have to compound. Even small annual contributions can grow substantially over several decades.
If you haven't reached the annual contribution limit by year-end, consider adding more before the contribution deadline.
3. Understand Capital Gains
Not every investment sale is taxed the same way.
If you sell an investment after holding it for one year or less, any profit is considered a short-term capital gain and is generally taxed at your ordinary income tax rate.
If you hold that same investment for more than one year, your profit becomes a long-term capital gain, which is usually taxed at a lower rate.
For many investors, waiting just a few extra weeks before selling can significantly reduce the taxes owed. Before selling a profitable investment, check how long you've owned it. The holding period can make a meaningful difference.
