Many investors are constantly seeking ways to reduce their tax burden, especially when it comes to capital gains from investments in stocks or other assets. One strategy that can help achieve this goal is tax-loss harvesting.
What is Tax-Loss Harvesting?
Tax-loss harvesting is a technique where you sell investments that have lost value in order to offset any capital gains you’ve realized from other investments. When you sell an asset at a loss, that loss can reduce the taxable capital gains from your other investments. Additionally, if your total capital losses exceed your gains, you can apply up to $3,000 of those losses to offset ordinary income each year. Any losses that go beyond this limit can be carried forward into future years, potentially reducing your taxes in the long run.
How Does Tax-Loss Harvesting Work?
- Sell a Losing Investment
The first step is identifying an investment that has declined in value. You sell this asset, realizing a loss. - Offset Capital Gains
The loss you’ve incurred from the sale can then be used to reduce any taxable gains you’ve made from selling other investments that have appreciated. For example, if you earned $10,000 from one stock but lost $4,000 on another, you can apply that $4,000 loss to reduce your taxable gain to $6,000. - Understanding the Ordering Rules
If you have both short-term and long-term gains and losses, there are specific rules for how these are offset. First, short-term losses are used to offset short-term gains, and long-term losses offset long-term gains. Any remaining losses in either category can then be used against the other category. - Capital Loss Carryovers
If your capital losses exceed your gains, you can deduct up to $3,000 of the remaining loss from your ordinary income each year ($1,500 if married filing separately). Any excess loss can be carried forward to offset future taxable income, potentially for years to come. - Be Careful with Reinvestment
After selling a losing investment, you might want to reinvest the proceeds. However, you should be cautious of the IRS’s wash-sale rule, which prevents you from buying a “substantially identical” investment within 30 days before or after the sale. If you violate this rule, you’ll lose the tax benefits of the loss, so it’s essential to wait the required 30 days before reinvesting in the same or similar asset.
Conclusion
Tax-loss harvesting can be a valuable strategy to reduce your taxes, especially when you’re managing a portfolio with both gains and losses. By carefully selling losing investments and offsetting gains, you can minimize your taxable income and potentially save money on your taxes. However, it’s important to follow the IRS guidelines, such as avoiding the wash-sale rule, to ensure you don’t forfeit the tax benefits. If you’re unsure how to implement tax-loss harvesting in your own situation, it may be wise to consult a tax professional for guidance.
