The Essentials of Tax-Loss Harvesting: A Guide to Potential Savings
Tax planning can be complicated, but strategies like tax-loss harvesting may offer opportunities to lower
your tax bill. If you’ve ever wondered how selling certain investments at a loss might actually work in your favor, this guide covers what tax-loss harvesting is, how it can help, and who it’s right for.
What is Tax-Loss Harvesting?
Tax-loss harvesting is a technique where investors sell investments in non-qualified accounts that have decreased in value to offset gains from other investments, potentially reducing their taxable income. In essence, you’re “harvesting” those losses to counterbalance gains, which can translate into lower taxes. Here’s how it works:
When you sell an asset at a loss, that loss can be used to offset capital gains—gains you’ve made from other investments.
If your losses exceed your gains, you can use up to $3,000 of those losses to reduce other taxable income (for example, your salary or other earned income).
Any remaining losses can be “carried forward” to future years, meaning they can offset gains or income down the line.
Benefits of Offsetting Capital Gains
The primary benefit of tax-loss harvesting is its potential to reduce your tax bill. This can be especially helpful if you’ve had significant gains throughout the year. By offsetting those gains with losses, you may lessen your tax liability. Here are a few ways it works:
Direct Tax Savings: Capital losses can offset capital gains dollar-for-dollar. For example, if you have $5,000 in gains and $3,000 in losses, you only pay taxes on the net $2,000 gain.
Ordinary Income Deduction: If your capital losses exceed your capital gains, you can deduct up to $3,000 (or $1,500 if married filing separately) from your other income, reducing your taxable earnings.
Long-Term Carryover: Losses beyond $3,000 can be carried forward to future tax years, offering potential ongoing tax savings.
Timing and Implementation: When Does Tax-Loss Harvesting Make Sense?
Tax-loss harvesting can be a valuable tool, but timing matters. The following scenarios can make it a beneficial strategy:
Year-End Tax Planning: Reviewing your portfolio toward the end of the year to identify potential losses can be a useful tax-planning strategy. Year-end assessments help you consider tax-loss harvesting before the calendar year closes.
Significant Gains: If you’ve had a profitable year with substantial capital gains, offsetting those gains with losses can reduce your overall tax burden.
Market Downturns: Periods of market volatility may leave certain investments with losses. Tax-loss harvesting lets you sell these assets, use the losses to offset gains, and potentially reinvest in more favorable opportunities.
Watch Out for the “Wash-Sale” Rule
While tax-loss harvesting can provide advantages, it’s essential to be aware of the IRS’s “wash-sale” rule, which limits how you can repurchase securities after selling them for a tax-loss harvest. Here’s how it works:
30-Day Rule: If you sell a security to capture a tax loss, you cannot repurchase the same or a “substantially identical” security within 30 days before or after the sale.
Penalties for Violations: Violating this rule disqualifies the loss from being claimed on your taxes. Carefully planning your transactions can help avoid this pitfall.
Other Considerations
While tax-loss harvesting can be useful, it’s important to look at the broader picture to see if it aligns with your overall financial strategy. Here are some things to consider:
Long-Term Goals: Tax-loss harvesting should complement your long-term investment goals, not override them. Selling at a loss may not always align with your larger financial objectives.
Transaction Costs: Frequent buying and selling can incur transaction fees, which may eat into your savings from tax-loss harvesting.
Impact on Your Tax Bracket: Harvested losses might affect your current and future tax brackets. Consulting with a financial advisor can help you understand these implications and make decisions that support your broader financial goals.
Who Might Benefit Most from Tax-Loss Harvesting?
Tax-loss harvesting isn’t for everyone, but it can be a useful tool for certain investors:
High-Income Investors: Individuals in higher tax brackets may see the most benefit, as reducing taxable income can have a greater impact.
Investors with Capital Gains: If you’ve realized capital gains during the year, tax-loss harvesting can help offset those gains.
Long-Term Planners: Those who plan to hold certain investments for the long term may use tax-loss harvesting selectively to optimize tax efficiency over time.
Key Takeaways
Tax-loss harvesting is a strategy that can help investors manage their tax liability by offsetting gains with losses. Here’s a quick recap:
Offset Capital Gains: Use losses from underperforming investments to reduce taxable gains.
Reduce Ordinary Income: If losses exceed gains, you may be able to offset other income up to $3,000 per year.
Long-Term Benefit: Losses can carry forward to future years, creating ongoing tax-saving opportunities.
Mind the Wash-Sale Rule: Avoid repurchasing the same or substantially identical securities within 30 days of a sale to preserve the tax benefit.
Tax-loss harvesting can be a helpful strategy for certain investors, but it’s essential to consider your financial goals and consult a financial advisor before diving in. With careful planning, tax-loss harvesting can play a role in an efficient, well-rounded tax strategy.
For financial questions, email us at office@staltfinancial.com, call 248-733-4344, or schedule a time at www.calendly.com/staltfinancial.
This content is for general information only and is not a recommendation to buy or sell investments. Estate and tax planning services are provided in conjunction with your attorney or CPA. Consult them for legal or tax advice. Stalt Financial does not guarantee the accuracy or completeness of third-party content linked here, which is provided for convenience only.
Stalt Financial, LLC is a Registered Investment Adviser.
*Tax Planning services are provided working in conjunction with your Tax Attorney and/or CPA.
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