Tax-Loss Harvesting: Turning Investment Losers into Tax Winners!
Tax-loss harvesting is a tax strategy that allows investors to offset capital gains with capital losses. This can help to reduce your overall tax liability.
As we like to say, “turn an investment loser, into a tax winner”!
How Does Tax-Loss Harvesting Work?
When you sell an investment at a loss, you can claim that loss on your tax return. This loss can then be used to offset capital gains that you have realized in the same year. If your losses exceed your gains, you can deduct up to $3,000 against your earned income and the remainder you can carry forward to future years.
There are two types of capital losses: short-term losses and long-term losses. Short-term losses are losses that you realize on investments that you have held for less than one year. Long-term losses are losses that you realize on investments that you have held for more than one year.
Short-term losses are used to offset short-term gains first. Any remaining short-term losses are then used to offset long-term gains. Any unused short or long-term losses can be carried forward to future years.
The Pros and Cons of Tax-Loss Harvesting
There are several pros and cons to consider when deciding whether or not to use tax-loss harvesting.
Pros:
Tax-loss harvesting can help to reduce your overall tax liability.
Harvesting losses can help offset gains from a concentrated stock position that you are trying to diversify.
Any remaining losses can be carried forward to future years.
You can deduct up to $3,000 worth of losses against your earned income each year.
Cons:
There is a risk that the investment that you sell will recover in value.
You must be careful not to repurchase the same investment within 30 days, or you will be subject to the wash sale rule.
How to Use Tax-Loss Harvesting to Reduce Capital Gains Taxes
Let's say that you have a taxable investment account with a $10,000 gain on one position and a $5,000 loss on another. If you sell the investment that has the $10,000 gain, you will owe capital gains taxes on that amount. However, if you sell the investment that has the $5,000 loss, you can use that loss to offset the gain. This will reduce your realized capital gains by $5,000. If we assume the investor is in the 20% long-term capital gains tax rate, that will reduce the tax liability from $2,000 owed to only $1,000 owed – cutting the taxes in half.
If you have more losses than gains, you can carry the losses forward to future years. This will allow you to offset future capital gains and reduce your tax liability. For example, if you have $10,000 in losses and no gains, you can deduct $3,000 of those losses against your earned income in the current year. The remaining $7,000 in losses can be carried forward to future years.
Conclusion
Tax-loss harvesting is a tax strategy that can help to reduce your capital gains taxes. However, there are some risks associated with this strategy, so it is important to weigh the pros and cons before using it. Here are some additional tips for using tax-loss harvesting:
Be careful not to repurchase the same investment within 30 days, or you will be subject to the wash sale rule. This will prevent you from deducting the losses on your tax return.
Consider using tax-loss harvesting to rebalance your portfolio. This can help you to keep your portfolio's risk level in line with your investment goals.
If you are considering using tax-loss harvesting, it is important to talk to a tax advisor to make sure that it is the right strategy for you.
DISCLOSURES:
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your attorney or tax advisor.
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Consilio Wealth Advisors, LLC (“CWA”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where CWA and its representatives are properly licensed or exempt from licensure.
