What is Tax Loss Harvesting?
Tax loss harvesting is the process of strategically selling certain investments at a loss in order to offset taxes on your capital gains. This is done by selling other investments in your portfolio for a profit.
For each calendar year, if the amount of your losses exceeds total capital gains, you can effectively reduce your capital gains taxes to $0. Additionally, as an investor, you can also reduce your ordinary income by up to $3,000 if there are any losses remaining after offsetting your capital gains.
How Does Tax Loss Harvesting Benefit You?
Let’s say you have two investments, well label them A and B. On investment A, you gained a profit of $40,000. On investment B, you lost $20,000. By harvesting your losses from investment B, you can deduct this loss in value from your total profit on investment A. This will allow you to save money by only paying taxes on $30,000 instead of $40,000.
Limitations You Should Consider
- Tax loss harvesting isn’t effective in retirement funds such as a 401K because the losses created by the tax deferred account can’t be deducted.
- When implementing these types of transactions, it is important to consider what is known as the wash-sale rule. This states that if you sell an asset at a loss within 30 days and buy the same or similar asset within that period, the loss will likely be rejected for current tax purposes.