What is Tax Loss Harvesting and How Can Investors Use It?

November 21, 20233 min read
What is Tax Loss Harvesting and How Can Investors Use It?
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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.

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 tax advisor 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 excess 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.

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