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As the end of the year approaches, selling activity among institutional investors typically rises, largely driven by tax-loss harvesting tips to reduce your tax bill. This time of year presents an opportunity to assess your portfolio and potentially use losses to offset capital gains, reducing your tax obligations.
Let’s walk through how tax-loss harvesting works, when it’s beneficial, and some key considerations to keep in mind before implementing this strategy.
Key Takeaways
- Use tax-loss harvesting to sell underperforming assets and offset gains, potentially lowering your taxable income.
- To avoid the wash-sale rule, ensure you don’t repurchase identical assets within 30 days to qualify for the tax deduction on losses.
- By harvesting losses before year-end, you can strategically reduce your tax bill and carry forward any excess losses to future years.
How Tax-Loss Harvesting Works
Tax-loss harvesting involves selling investments that have lost value to offset gains from profitable sales. When you offset gains with losses, you’re taxed only on the net amount, which can significantly reduce your tax bill.
For instance, if you sold an investment for a $10,000 gain, you might sell another investment at a $10,000 loss, potentially eliminating the taxable gain.
Benefits of Tax-Loss Harvesting Beyond Offsetting Gains
The advantages of tax-loss harvesting can go beyond balancing gains and losses. If your losses exceed your gains, you may use up to $3,000 of those losses to offset other types of income. Any remaining loss can then be carried forward to future tax years.
Suppose you realized a $15,000 loss but only a $10,000 gain. You can use $3,000 of the extra $5,000 loss to offset other income, while carrying over the remaining $2,000 for future tax filings.
Key Tips for Successful Tax-Loss Harvesting
Tax-loss harvesting can be a valuable strategy, but it requires careful planning to be effective. Before you start selling underperforming assets, it’s important to understand the key rules and tactics that can help you maximize tax savings without compromising your long-term financial goals.
Here are some tips to help you implement tax-loss harvesting in a way that aligns with your overall investment strategy:
Be Mindful of the Wash-Sale Rule
The wash-sale rule disallows claiming a loss if you repurchase the same or a substantially identical asset within 30 days before or after selling it. If you still want exposure to a similar investment, consider buying a comparable asset instead to avoid triggering the rule.
An example of substantially identical assets would, obviously, be the same exact stock, or two mutual funds or Exchange Traded Funds (ETFs) that track the same index, like the S&P 500. However, the wash-sale rule most likely does not apply to selling AT&T and buying Verizon.
Match Your Gains and Losses Strategically
While you may be tempted to accrue more losses than gains to carry forward, consider the time value of money. A loss today may be more valuable than in the future, especially if you expect to be in a lower tax bracket down the road. It’s best to harvest losses in a way that aligns with your near-term tax goals.
For example, imagine you’re currently in the 24% tax bracket but expect to be in the 12% bracket in a few years when you retire. If you take a $10,000 loss today to offset gains, that loss reduces your taxable income by $10,000 at a 24% rate, saving you $2,400 in taxes (10,000 * 0.24).
However, if you wait to use that same $10,000 loss in the future when you’re in the 12% tax bracket, it would only save you $1,200 in taxes (10,000 * 0.12).
By harvesting the loss now, you maximize your immediate tax savings. Additionally, any tax savings you realize today can be reinvested or used to reduce your current financial obligations, potentially compounding the benefit over time.
Ensure This Strategy Fits Your Portfolio Goals
While tax-loss harvesting can reduce taxes, it may not suit every portfolio. For instance, if the underperforming securities you’re considering selling have the potential to recover, or if your profitable investments still have room to grow, it might make sense to hold onto them rather than selling just for tax purposes. Be sure to assess your long-term investment goals before deciding.
Take Advantage of Market Volatility for Harvesting Opportunities
A year with market volatility can create opportunities for tax-loss harvesting. Price fluctuations often result in both winners and losers within a portfolio, offering opportunities to realize losses. Rather than fearing market dips, use them as a chance to optimize your tax strategy.
Tax-loss harvesting is a powerful tool for managing taxes and aligning your portfolio with your financial goals. But as with any tax strategy, it’s not one-size-fits-all. Assess your personal financial situation, and consult a tax or financial advisor if needed, to make the most of this end-of-year opportunity.
For more information on capital losses, refer to the IRS’s Publication 550: Investment Income and Expenses ↗. This publication provides comprehensive guidance on the tax treatment of investment income and expenses, including capital gains and losses.
Additionally, Topic No. 409: Capital Gains and Losses ↗ offers a concise overview of how capital gains and losses are taxed.