Exactly that's what I knew, obviously you want all the eventual gains to be long term, but a loss is a loss, short or long term doesn't make a difference.
But maybe I missed something I'm not American and I've only been here 5 years.
Just wanted to be sure, thanks
The reason short term is better for a loss is that it cancels out short-term gains first before income. Long-term can only cancel out long-term gains before income, and the income is limited to $3k losses per year (carries over).
Let's say you had $5k gains this year from rebalancing earlier in the year (short-term), then the market goes to shit and you rebalance again. Let's also say that if you rebalance today it's short-term and if you do it tomorrow, it's long-term. You will incur $10k of losses in the rebalancing.
If you rebalance today, you get $10k of short-term losses, which cancels out the $5k of gains and leaves you with $5k to write off on your taxes ($3k this year, $2k next year) or cancel future short-term gains. If you rebalance tomorrow, you get $10k in long-term losses, which you can write off against income ($3k for three years, $1k the final year) or future long-term gains. Note that long-term losses do not cancel out all of the short-term gains. You'd still pay taxes on the $2k and be unable to reduce income farther.
Hopefully that helps to better understand it.
Thanks a lot for the explanation, super clear and very good to know.
I actually almost never sell and rebalance only through buying so it never made a difference for me
No Absolutely not. That's not how it works.
First long term losses cancel long term gains, and short term losses cancel short term gains. If you have long term losses and short term gains, you net the long term losses against the short term gains. If you have short term losses and long term gains, you net the short term losses against the long term gains.
So in your example Pooperman, if you rebalance tomorrow. you have $10k of long term losses, which you net against your long term gains of zero, and then you net that against your $5k of short term gains. Now you have $0 in short term capital gains, and $5k in long term losses. You use $3k against income, and carry forward $2k of long term losses to next year.
To see this,
download schedule D.
You have a net short term capital gain of $5k on line 7.
You have a net long term capital loss of $10k on line 15.
On the back, line 16, combine lines 7 and 15: $-5k. This is a loss, skip lines 17 to 20, go to line 21.
On line 21, enter ($3000).
Now to figure out the carryover. Go to page 11 of the
schedule D instructions.
That's the 2014 instructions, so you'd carry over 2013's losses. Replace 2014 with 2016, and 2013 with 2015.
Line 1: (Some large number, capital losses are disallowed if you don't have taxable income)
Line 2: 3000
Line 3: 3000
Line 4: 3000
Line 7 of 2015's Schedule D is a short term capital gain of $5k. We enter zero on line 5 and go to line 9
Line 5: 0
Line 9: $10k (Line 15 of 2015's Schedule D is a long term capital loss of $10k)
Line 10: $5k
Line 11: $3k
Line 12: $8k
Line 13: $2k.
Line 13 is our long term capital loss carryover for 2016.
Here's the example where short term losses are more valuable than long term losses. I'm going to try make it as dramatic as possible.
Suppose you're in the 15% marginal bracket (and therefore 0% long term capital gain (LTCG) bracket)
Suppose you have $5k in short term capital gains (STCG) and $5k in (LTCG). You have $7k of unrealized STCL that will become unrealized LTCL tomorrow.
If you sell and incur $5k of STCL today, you have a net $0 STCG, and a $5k LTCG. You're in the 0% LTCG bracket, so your taxes on all your capital gains and losses is $0.
If you sell and incur $5k of LTCL tomorrow, you have a net $5k STCG, and a $5k LTCG. You're taxed 15% * $5000 = $750 on STCG, and 0 on your LTCG. Your net taxes paid on all capital losses and gains is $750.
Now notice I said you have $7k of unrealized STCL. What if you sold for a $7k STCL today?
You would have a $2k STCL, and a $5k LTCG. You net these together, and you have a net $3k LTCG. You're in the 0% LTCG tax bracket, so your taxes on capital gains and losses is zero. BUT, if you sold to incur the $7k STCL to TLH, then this was stupid. You haven't changed your tax bill at all (compare it to the above where you realize $5k of STCL). But you have lowered the basis of the funds you just TLH'd. Meaning you will realize a larger capital gain in the future.
What if you sold for a $7k LTCL tomorrow?
You would have a $2k LTCL and a $5k STCG, which net against each other, so you have a $3k STCG. You owe taxes of 3000*.15 = $450 for your capital loses and gains.
Clearly, it is best to incur up to $5k of STCL today (but no more, because then you're lowering your LTCG which you owe no taxes on anyways)