Taxable Account Up, but 1099 Shows Losses. What Gives?

Last week a client asked, "by my calculations, I was 'up' on the year, why does my tax form show that I had losses?"

The short answer: Tax-Loss Harvesting (TLH).

As a follow-up to my post on rebalancing, I wanted to briefly talk about tax-loss harvesting and why/how it's a great tool for clients with taxable accounts (aka non-IRA's).

For those that want to get into the weeds, here is an article from Schwab that does just that.

However, for this post, I want to keep it simple.

If an investor buys a stock (A) for $100 and it goes to $150, they have a gain of $50 (simple enough, right?). But what happens if they hold that stock for years on end without selling it? That $50 gain is an "unrealized" gain - meaning that it hasn't been "realized" for the sake of taxes. They could choose to hold it forever if they want, and (assuming the stock doesn't pay dividends or has any other taxable events) keep "deferring" the capital gains tax.

If they choose to sell it, then the gains would be considered "realized" for tax purposes and then it would show up on a 1099.

But what if the investor buys a $100 stock in a different company (B) and that stock declines to $50? If the investor continues to hold the stock, they would have "unrealized" losses. However, if they choose to sell the stock, the losses are then "realized" for tax purposes.

At the end of the day, if they sold both shares of company A and company B, they would show a $0 in the gain/loss column.

Now enter the wild year that was 2020. The stock market went down 30-something percent in a matter of a month or so. On paper, an investor might've shown losses. They could've (hopefully) remained optimistic about their long-term investing strategy, but wanted to make a few tweaks. They could've rebalanced their portfolio, sold some investments that were down, and bought other investments that were still in line with their long-term strategy. When they sold the investments at a loss, those investments were now "realized" losses for tax purposes. But we know what happened, the market came roaring back to finish out the year, which probably caused investors to have gains in the investments that they purchased in the spring of 2020. If they then continued to hold their investments into 2021, on paper (your 1099) it could've still shown a loss.

Simply put:

1. An investor sells investments at a loss in March 2020

2. The investor then buys other investments (being mindful of wash-sale rules)

3. The investor holds their newly purchased investments that have gone up into 2021

4. On the investor's 1099, it shows a capital loss, even though their account is higher now that it was at the beginning of 2020

We always talk to clients about controlling what they can control. Although we cannot control what happens day-to-day in the market, we can take advantage of TLH opportunities when they present themselves.