What is tax loss harvesting and how can investors use it?
With tax-loss harvesting, you can sell investments that are down to offset realized gains. Then reinvest the proceeds in assets aligned to your goals in the current environment.
Amid the current market volatility, investors may be looking to take advantage of tax-smart strategies to offset some of their losses from this year. Fortunately, a losing investment can have a silver lining in terms of taxes. Through a strategy known as tax-loss harvesting, investors may be able to use their losses to lower their tax liability, while better positioning their portfolio going forward. The strategy generally works like this:
- Investors sell a stock that has sustained losses during the year..
- They then use the loss they’ve incurred from the sale of the stock to offset taxable short- and long-term capital gains, as well as up to $3,000 of their ordinary income.
- Investors reinvest the proceeds in assets aligned to their goals in the current environment, potentially private markets.
In context: Tax-loss harvesting
Let’s suppose healthcare stocks rise sharply while tech stocks drop in value. To realign their investments with assets that are performing well, investors may sell some healthcare stocks and use those funds to rebalance their portfolio, which would mean a tax gain.
This is where tax-loss harvesting can come in. The investor can use the loss of selling the tech stocks that have declined in value to offset the gain from selling the healthcare stocks, which reduces their overall tax liability.
If the losses are larger than the gains, the remaining losses can also be used to offset up to $3,000 of ordinary taxable income. Unused losses can be carried forward indefinitely.
Tax-loss harvesting considerations
The U.S. tax code has specific rules related to tax-loss harvesting, so be sure to consult your accountant before making any decisions. Some common pitfalls investors may encounter include:
- Tax-loss harvesting isn’t useful in retirement accounts, such as a 401(k) or an IRA, because they can’t deduct the losses generated in a tax-deferred account.
- There are also some restrictions on using certain losses to offset certain gains. For example, a long-term loss can only be applied to a long-term gain, while a short-term loss would be applied to a short-term gain. If there’s a loss that’s in excesss in one category, it can then be applied to gains of either type.
- There are rules against intentionally buying and selling stocks that are “substantially identical” for a tax benefit. The wash-sale rule, which states that if an investor sells a security at a loss and buys the same or a “substantially identical” security within 30 days before or after the sale, the loss is generally disallowed for current income tax purposes.
The deadline to harvest losses from this year is December 31.
Reinvest with more stability
Stock market volatility continues to remain high and forward-looking returns are lower. Consider selling your underperforming stocks to allocate to private markets without the tax burden.
All investments involve risk, including the possible loss of capital. There can be no assurance that any product or strategy described herein will achieve any targets or that there will be any return of capital. Past performance is not a guarantee or reliable indicator of future results. Current performance may be lower or higher than the past performance data quoted. Any historical returns, expected or target returns are hypothetical in nature and may not reflect actual future performance. All performance and/or targets contained herein are subject to revision by Yieldstreet and are provided solely as a guide to current expectations.
Yieldstreet cannot and does not provide tax advice and this communication is for illustrative purposes only and is not intended to be – and should not be construed as – tax advice. U.S. tax code has several specific rules related to tax-loss harvesting and related matters.Please consult a tax professional for advice specific to your situation. Further, this communication should neither be construed nor intended to be a recommendation to purchase, sell or hold any security or otherwise to be investment, financial, accounting, legal, regulatory or compliance advice.
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