Tax Loss Harvesting - An Overview

Tax Loss Harvesting - Make Lemonade
Turn a portion of your investment losses into tax offsets, making a little lemonade out of investment "lemons."

Tax-loss harvesting is a strategy of incurring capital losses to offset taxes owed on capital gains, or even taxes owed on personal income. While this doesn’t eliminate losses, it can leverage them for tax savings. Some investors harvest losses throughout the year, while others just do it annually in conjunction with year-end portfolio rebalancing and review.

The tax-loss harvesting process overview:
1) Sell securities that have lost value.
2) Use the capital loss to offset capital gains on other sales.
3) Replace the sold investments with similar investments, but not too similar as per the "wash out" rule, to maintain the desired investment exposure.

Investors use this process to balance out net gains. Even those who do not report capital gains can benefit from tax loss harvesting because up to $3,000 of capital losses beyond capital gains can be used to offset taxes on ordinary income for single filers and married couples filing jointly. Any remaining capital losses above that can be carried forward to offset capital gains the following year.1

A wash sale transaction involves the sale of one security and consequent purchase of a "substantially identical" stock or security within 30 days before or after the sale. Transactions considered as wash-sales cannot be used to offset capital gains and can result in fines or trading restrictions if deemed abusive. The wash-sale rule applies to an entire taxable portfolio and multiple taxable accounts – worth remembering for spouses filing taxes jointly.2

Tax loss harvesting most often deploys short term losses to limit the amount of taxes due on short-term capital gains, which are generally taxed at a higher rate than long-term capital gains. However, the method may also use long term losses to offset long-term capital gains. Tax-advantaged accounts are ineligible for this strategy.3

Taking losses in the current year and carrying excess losses into next year allows investors to potentially shelter some or all of their long-term and short-term capital gains next year.


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