How to Use Capital Losses to Reduce Your Freelance Tax Bill

While the current investment market may not have created ongoing capital gains for many people, it certainly may have created some capital losses. A capital loss occurs when you sell a stock or an investment at a lower price than you originally bought it for. If this applies to you, take heart, you may be in a position to leverage tax-loss selling to reduce your freelance tax obligations before the end of the year.

The end of the calendar year is when many investors consider whether it is beneficial to use tax-loss selling of stocks to reduce the amount of tax they need to pay on capital gains and potentially other tax obligations. You can deduct up to $3,000 per tax year in capital losses, if they are qualified and not part of a wash sale.

Note that wash sale rules apply to securities, but at the present they do not apply to cryptocurrencies. This may change in the future. In addition, certain states may not allow you to carry forward a capital loss. For example, New York and California allow for this but not New Jersey, so check your own state rules to make sure you follow compliance.

What is a wash sale and how can it affect your freelance taxes?

Current tax law states that if you buy a security within 30 days before or after selling it, any losses from that sale cannot be counted against reported income. This regulation is designed to remove the incentive to do what is referred to as a short-term wash sale.

The IRS is well aware of the potential to use tax losses to offset capital gains and more, so here is how the IRS defines and tries to prevent a wash sale:

• Under the wash sale rule, investors cannot claim a capital loss for tax purposes if they repurchase the stock or security within 30 days.
• The IRS considers a transaction a wash sale if you do any of the following 30 days before or after a sale of an investment:
• Purchase the same investment.
• Purchase a substantially similar investment.
• Enter into a contract to buy a similar investment.
• Acquire a similar stock for an IRA or Roth IRA.
• The wash sale rule applies for 30 days before and after the transaction, which means it is actually a 61-day window.
• The wash sale rule also applies if an individual sells a security, and their spouse or a company controlled by the individual buys a substantially equivalent security during the 61-day wait period.

Obviously, the wash rule is something you want to avoid, and you can do so and still use capital gains to offset your losses and reduce your freelance tax bill. Here’s how:

• Keep your investment for at least one year, less than this and the profit is treated as regular income and you'll have to pay higher tax rates (see the details below).
• Deduct any losses from your investment profit up to $3,000 a year per the IRS rules.
• With losses greater than $3,000, carry them forward and deduct them from your capital gains in future years.
• Record any qualifying expenses related to making or maintaining your investments, which can also be used to lower your tax bill.

It is also important to know the capital gains tax rates for your specific situation. Here are the 2022 capital gains tax rate thresholds:

Source: IRS.gov

Of course, taxes should not be the main driver of your investment planning, but it is important to understand how to leverage losses to reduce any capital gains and also to guide your overall tax planning strategy. As the year closes, consider this information as you assess your tax situation and your overall investment strategy with a tax and financial planning professional.