Written by What Is Tax-Loss Harvesting?
- Definition: Tax-loss harvesting is a strategy used by investors to offset capital gains by selling securities at a loss, thus reducing taxable income.
- Capital Gains: Investors are required to pay taxes on capital gains earned from the sale of investments that have appreciated. Tax-loss harvesting helps lower this tax liability.
- Tax Efficiency: The strategy is particularly beneficial in taxable accounts, where investment gains are taxed.
How Tax-Loss Harvesting Works
- Sell Underperforming Investments: The first step in tax-loss harvesting is selling investments that have declined in value.
- Offset Capital Gains: Losses from the sale of these underperforming investments can be used to offset any gains you’ve made from other investments.
- Carry Over Losses: If your losses exceed your capital gains, you can apply up to $3,000 in losses to offset other income, such as wages. Losses greater than this amount can be carried forward to future tax years.
Example of Tax-Loss Harvesting
- Scenario: You sell a stock for a gain of $10,000, but you also sell another stock for a loss of $5,000. The taxable capital gain would be reduced to $5,000 ($10,000 gain – $5,000 loss).
- Long-Term Strategy: While tax-loss harvesting can be a powerful strategy, it is best utilized in conjunction with long-term investment goals, rather than purely for tax savings.
Important Considerations
- Wash Sale Rule: The IRS prohibits the repurchase of the same or substantially identical securities within 30 days before or after the sale. This is known as the “wash sale” rule, and it ensures that tax-loss harvesting isn’t abused.
- Focus on the Big Picture: While tax-loss harvesting offers tax benefits, it should not be the sole reason for making investment decisions. Focus on your overall portfolio strategy and long-term goals.
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