Usually we think of strategies to prevent us from paying taxes on higher incomes when the markets are doing well or our job is paying well. It actually works both ways. So if you're depressed over losing money, cheer up. Here's ways you can use those losses to your benefit.
1. Convert to a Roth IRA: With portfolio values lower, traditional Individual Retirement Accounts can be converted to Roth IRAs. Why now? When you convert, tax is due on the amount converted. If your IRA is down to $100,000, for example, from $125,000, you'll pay tax on $100,000 instead of $125,000. And when the value recovers over the years and it comes time to take it out in retirement, withdrawals will be tax free. Since conversion values are considered ordinary income, watch that it doesn't push you into a higher tax bracket. You may want to convert only a portion up to the limit of your current tax bracket.
2. Reverse a Roth conversion: If you converted earlier this year (when it was $125,000 in our example above), you could reverse it now and take your chance the value will still be lower next year and do another conversion after Jan. 1, unless it's in December, in which case the next conversion has to be at least 30 days later. Conversions can be done only once a year.
3. Write off losses: Selling stocks at a loss gives you a tax deduction for the amount you lost in the sale. If your $10,000 stock, ETF, bond or mutual investment is now worth $8,000, you'll get a $2,000 deduction, called a capital loss. You can deduct up to $3,000 in losses a year, with anything more carried over to the following year's taxes. If you still believe in the investment, you can buy it back after 30 days. The IRS does not allow a sale and buyback within 30 days in order to claim a tax loss.
So cheer up, you may have lost money in investments but you can get a lower tax bill.