Tax-Loss Harvesting: A Year-End Strategy to Manage Taxes
Key Takeaways
- Lemonade from Lemons: Turn your investment losses into a tax break. Sell losing stocks to offset gains from winners.
- $3,000 Bonus: If your losses exceed your gains, you can deduct up to $3,000 from your ordinary income (like your salary).
- Beware the Wash Sale: Don’t buy the same stock back within 30 days, or the IRS will disallow your tax deduction.
Tax-loss harvesting is a commonly used year-end approach in which investors realize capital losses to offset gains. While it does not change the performance of an investment, it can influence the timing of tax obligations.
Strategic Insight: The strategy provides a way to reduce taxable gains and potentially lower current-year tax liability, while unused losses may be carried forward to future years.
How Loss Offsets Work
| Priority | Application Rule |
|---|---|
| 1. Offset Capital Gains | Losses first offset gains of the same type (short-term with short-term, then long-term). |
| 2. Deduct From Income | If losses exceed gains, up to $3,000 per year may offset ordinary income. |
| 3. Carryforward | Remaining unused losses may be carried over to future tax years indefinitely. |
Estimated Impact Example
The chart below illustrates a simplified scenario showing how a realized capital loss may reduce overall tax liability under a 15% long-term capital gains rate.
The Wash-Sale Rule: Don’t Get Caught
To claim a capital loss deduction, an investor must avoid purchasing the same or a “substantially identical” security within 30 days before or after the sale. Observing this rule is essential to ensure the loss is recognized for tax purposes.
Practical Steps to Consider
1
Review Your Losers
Look at your taxable brokerage account. Are any holdings significantly below your purchase price (cost basis)? These are your harvesting candidates.
Look at your taxable brokerage account. Are any holdings significantly below your purchase price (cost basis)? These are your harvesting candidates.
2
Realize the Loss
Sell the asset to lock in the loss. This loss can now be used to cancel out capital gains taxes you would otherwise owe.
Sell the asset to lock in the loss. This loss can now be used to cancel out capital gains taxes you would otherwise owe.
3
Reinvest Thoughtfully
Don’t sit in cash. Buy a similar but not identical ETF (e.g., sell Coca-Cola, buy Pepsi or a Consumer Staples ETF) to stay invested while avoiding the wash-sale rule.
Don’t sit in cash. Buy a similar but not identical ETF (e.g., sell Coca-Cola, buy Pepsi or a Consumer Staples ETF) to stay invested while avoiding the wash-sale rule.
Frequently Asked Questions
Q. What is Tax-Loss Harvesting?
Tax-loss harvesting refers to the strategy of selling investments at a loss to offset capital gains. If total losses exceed gains, up to $3,000 of the remaining loss can be applied against ordinary income each year.
Q. What is the Wash-Sale Rule?
The Wash-Sale Rule requires that a taxpayer cannot deduct a loss if they purchase the same or a substantially identical security within 30 days before or after the loss sale. This rule prevents investors from claiming a tax loss while maintaining the same market position.
Disclaimer: This material is provided for educational purposes only and does not constitute tax or investment advice. Tax-loss harvesting rules, including the Wash-Sale Rule, can be complex. Consult a qualified tax professional regarding your specific situation.