The general principle behind tax-loss harvesting is straightforward, but it’s best to plan your strategy to avoid some common pitfalls. For many investors, tax-loss harvesting is the most critical tool for reducing taxes. Using the tax-loss harvesting strategy, investors can realize significant tax savings.
Visit the Charles Schwab website here for more information.
Understanding Tax-Loss Harvesting
Tax-loss harvesting is the selling of securities at a loss to offset a capital gain tax liability. Usually, this strategy is implemented near the end of the calendar year but may happen at any time in a tax year.
How Does Tax-Loss Harvesting Work?
- You sell an investment that’s underperforming and losing money.
- Then, you use that loss to reduce your taxable capital gains and potentially offset up to $3,000 of your ordinary income.
- Finally, you reinvest the money from the sale into a different security that meets your investment needs and asset-allocation strategy.
Issues To Consider
- Tax-loss harvesting isn’t useful in retirement accounts, such as 401(k) or an IRA because you can’t deduct the losses generated in a tax-deferred account.
- Do you need to reduce or accelerate taxable income? Just because you can realize losses doesn’t always mean you should.
- A long-term loss would first be applied to a long-term gain, and a short-term loss would be applied to a short-term gain. If there are excess losses in one category, these can be applied to gains of either type. Net capital loss deduction is limited to $3,000 on federal income tax return.
- When conducting these types of transactions, you should also be aware of the wash-sale rule, which states that if you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale, the loss is typically disallowed for current income tax purposes.