Tax losses: A loss on the sale of a security can be used to offset any realized investment gains, and then up to $3,000 in taxable income annually. Some tax-loss-harvesting strategies try to take advantage of losses for their tax benefits when rebalancing the portfolio, but be sure to comply with Internal Revenue Service (IRS) rules on the tax treatment of gains and losses.
Loss carryforwards: In some cases, if your losses exceed the limits for deductions in the year they occur, the tax losses can be "carried forward" to offset investment gains in future years.
Capital gains: Securities held for more than 12 months are taxed as long-term gains or losses with a top federal rate of 23.8% (versus 40.8% for short-term gains) as of 2018. Being conscious of holding periods is a simple way to avoid paying higher tax rates.
Fund distributions: Mutual funds distribute earnings from interest, dividends, and capital gains every year. Shareholders are likely to incur a tax liability if they own the fund on the date of record for the distribution in a taxable account, regardless of how long they have held the fund. Therefore, mutual fund investors considering buying or selling a fund may want to consider the date of the distribution.
Tax-exempt securities: Tax treatment for different types of investments varies. For example, municipal bonds are typically exempt from federal taxes, and in some cases receive preferential state tax treatment. On the other end of the spectrum, real estate investment trusts and bond interest are taxed as ordinary income—with rates up to 37% for the top income tax bracket in 2018. Sometimes, municipal bonds can improve after-tax returns relative to traditional bonds. Investors may also want to consider the role of qualified dividends as they weigh their investment options. Like long-term capital gains, qualified dividends are taxed at a top rate of 23.8%. Qualified dividends are subject to the same tax rates as long-term capital gains, which are lower than rates for ordinary income. (See Qualified Dividends for more information.)
Fund or ETF selection: Mutual funds and exchange-traded funds (ETFs) vary in terms of tax efficiency. In general, passive funds tend to create fewer taxes than active funds. While most mutual funds are actively managed, most ETFs are passive, and index mutual funds are passively managed. What's more, there can be significant variation in terms of tax efficiency within these categories. So, consider the tax profile of a fund before investing.
Source: Fidelity Investments
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