Gabe Fransen | October 15, 2024

Tax loss harvesting could be a strategic approach to turn investment losses into tax benefits. It involves selling investment positions at a loss to offset capital gains and/or reduce taxable income.

When you sell an investment at a loss, you can use that loss to offset capital gains you’ve realized from selling other investments at a profit within the same tax year. If your losses are more than your gains, you can deduct up to $3,000 (joint filers)/ $1500 (single filers) from your ordinary income. Any remaining loss can be carried forward to offset future gains or income.

The Steps:

  • Identify Losses: You would identify securities in your portfolio that have decreased in value since purchase.
  • Selling at a Loss: Sell these positions before the end of the tax year to realize the loss.
  • Reinvestment: After selling, there’s a 30-day waiting period before you can buy back the same or a “substantially identical” position due to the wash sale rule. However, you can invest in a similar but not identical security to maintain your investment strategy.
  • Offsetting Gains: Use the realized loss to offset any capital gains. If your losses are more than your gains, you can apply the excess against your income up to the previous mentioned limits.

Additional Benefits

  • Portfolio Rebalance: Harvesting losses can help naturally rebalance your portfolio, potentially aligning it more closely with your risk tolerance and investment goals.
  • Tax Efficiency: By reducing your tax liability, you potentially could increase your after-tax returns, which can be reinvested to compound over time.
  • Flexibility in Investment Strategy: While waiting out the 30-day period, you might explore new investment opportunities or adjust your strategy based on current market conditions.

Additional Considerations

  • Wash Sale Rule: Be cautions of the wash sale rule. If you buy back the same or similar position within 30 days after selling, the loss might not be deductible.
  • Market Timing: While waiting out the 30 days, consider the market’s volatility. Timing can affect your investment returns.
  • Future Tax Rates: Since tax rates can change, the strategy’s effectiveness might depend on current and future tax environments.
  • Not for All Accounts: Tax loss harvesting is only beneficial in taxable accounts. Retirement accounts like IRAs or 401(k)s don’t benefit from this strategy since gains and losses are not taxed until withdrawal.

Tax loss harvesting can be particularly beneficial during market downturns or when specific sectors underperform. It’s not just about reducing taxes but about portfolio management. Investors should be mindful that harvesting does not derail their long-term investment strategy. Consider discussing the benefits of tax loss harvesting with a financial advisor and tax professional to tailor this strategy to your specific financial situation and goals.

 

IRS Topic no. 409, Capital gains and losses: https://www.irs.gov/taxtopics/tc409