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Tax loss harvesting is a technique investors use to offset capital gains and reduce overall tax burden. By strategically selling investments that have experienced a loss, you can generate losses and use them to offset capital gains from other investments, ultimately lowering your taxable income. While this strategy can be helpful, you must understand what it is, the tax loss harvesting rules, and the limits.
What is the Concept of Tax Loss Harvesting?
Investors strategically employ tax loss harvesting to minimize their capital gains taxes. Tax loss harvesting centers on selling investments that have incurred losses to balance out gains from other investments.
As an investor, you may notice securities in your portfolio that have fallen below the purchase price. You could sell them and make a capital loss. These would become harvestable tax losses.
The harvestable tax loss can offset any capital gains from other investments. For instance, if you have realized gains from selling other assets at a profit, tax loss harvesting can neutralize some or all of those gains. The result is a reduction in your taxable income and capital gains tax, which lowers your tax liability.
Suppose the amount of realized capital losses surpasses the realized capital gains in a specific tax year. In that case, it may be possible for you to carry over the excess loss and use it to offset future gains or ordinary income.
How to Do Tax Loss Harvesting Step-by-Step?
Are you still wondering how tax loss harvesting works? These are the steps involved in this strategy:
- Identify the security that you want to sell. They should be ones that lost value in the market.
- Assess your portfolio for assets that make a capital gain.
- Sell the securities you identified for a capital loss.
- Reinvest in securities similar to the one you sold to maintain your market exposure.
- Record all transaction details for accurate tax reporting.
Tax loss harvesting is about minimizing your current tax bill and setting you up for future success. By strategically rebalancing your portfolio and taking advantage of market downturns, you can position yourself for potential gains when the market recovers. However, you should hire a financial advisor and tax consultant to get a sound strategy for your investments.
The Wash Sale Rule
When considering this approach, you must consider this tax loss harvesting rule. It is common for investors to strategically reinvest the funds from a losing investment into a similar, substantially different asset.
Using this strategy, you can effectively navigate the market without violating the "wash-sale" rule. This tax loss harvesting rule prevents you from deducting losses if you repurchase the same or a significantly identical security within 30 days before or after selling it. This is a tax loss harvesting limit you need to pay attention to.
What Is an Example of Tax Loss Harvesting?
For instance, if you bought shares in a company for $15,000 and they have grown to $20,000, you could realize a capital gain of $5,000 if you sold them. You made another investment of $10,000 in another company that decreased to $6,000—a capital loss of $4,000.
If you sell them both, you only have to pay a capital gains tax on $1,000. You can reinvest the second $6,000 from your second investment into a similar asset. However, if you had no gains to offset, you could use the $4,000 loss to offset other taxable income.
What Are the Benefits of Tax Loss Harvesting?
By implementing tax loss harvesting, you can unlock many advantages that significantly decrease your tax obligations.
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Reduces Tax Liability
You can effectively offset any gains from other investments, potentially reducing or even eliminating the taxes you owe. If you experience more losses than gains in a given year, there is a potential benefit for you. You can utilize these excess losses to offset a portion of your ordinary income, effectively reducing your tax liability.
Improves Overall Portfolio Performance
Tax loss harvesting allows you to maintain your portfolio's overall balance and strategy while realizing tax advantages. You can keep your desired market exposure by reinvesting in similar but not identical assets. Selling losing investments allows you to rebalance your portfolio in line with your long-term investment goals, possibly by reinvesting in assets better aligned with your strategy.
Enhances After-Tax Returns
This smart financial strategy can substantially enhance your after-tax returns by strategically minimizing your tax liabilities. Imagine keeping more of your hard-earned money working for you and accelerating the growth of your investment portfolio.
Get Professional Tax Loss Harvesting Help
Our team of experts understands the complexities of tax loss harvesting and can guide you through the process. We'll analyze your portfolio, identify the suitable investments to sell, and help you minimize your tax liabilities while maximizing your long-term investment potential.
Don't let taxes eat into your hard-earned money. Take control of your financial future with tax loss harvesting.
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Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
