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What is Tax Loss Harvesting & How Can You Benefit?

Tax loss harvesting is a practice of offsetting capital gains taxes by selling investments at a loss and using the losses to reduce taxable income. When done strategically, tax loss harvesting can help investors save money on taxes. In this blog post, we will discuss how to maximize your returns through tax loss harvesting. 


What is tax loss harvesting? 

Tax loss harvesting is a strategy employed by investors to reduce their taxable income by offsetting capital gains with capital losses. It involves intentionally selling investments that have experienced losses in order to generate capital losses that can be used to offset capital gains.

The purpose of tax loss harvesting is to minimize an investor’s tax liability by strategically managing their investment portfolio. By realizing losses on certain investments, investors can reduce their overall taxable income, potentially lowering the amount of tax they owe. The concept is based on the principle that losses can be used to offset gains, thereby reducing the net taxable gain.

What are capital gains & losses? 

Short-term Capital Gains and Losses: Short-term capital gains and losses occur when assets are held for one year or less before being sold or disposed of. They are subject to ordinary income tax rates, which are the tax rates applied to your regular income. Short-term capital gains are typically taxed at your marginal income tax rate, which can range from 10% to 40% depending on your income level.

Long-term Capital Gains and Losses: Long-term capital gains and losses arise when assets are held for more than one year before being sold or disposed of. They benefit from preferential tax rates, which are generally lower than ordinary income tax rates. The long-term capital gains tax rates vary based on your taxable income and are typically lower than short-term capital gains tax rates. As of 2023, the long-term capital gains tax rates are as follows:

  • For individuals with taxable income up to $44,626 (single filers) or $89,250 (married filing jointly): 0% tax rate.
  • For individuals with taxable income between $40,401 and $492,300 (single filers) or $89,250 and $553,850 (married filing jointly): 15% tax rate.
  • For individuals with taxable income above $492,301 (single filers) or $553,851 (married filing jointly): 20% tax rate.

It’s important to note that these tax rates are subject to change based on tax law revisions or updates. It’s advisable to consult with a tax professional or refer to the latest tax regulations for the most accurate and up-to-date information

How does tax-loss harvesting work? 

Tax loss harvesting works by recognizing losses on investments that have decreased in value due to market forces or other factors. These losses can be used to offset any taxable gains made during the year. This means that you are able to reduce your taxable income and pay less in taxes.

Let’s look at the example below. In this case, an investor has two investments, A & B, with one in a loss position and one having a gain. The investor is able to take $25,000 in losses by selling investment B that both offset capital gains on investment A as well as reduced his ordinary income by $3,000 with additional losses leftover for future gains in their portfolio. In this case, it creates $8,050 in tax savings and the potential for future additional tax savings with the $3,000 in additional losses rolled forward to offset future capital gains. 

Benefits of Tax Loss Harvesting

Benefits of Tax Loss Harvesting:

  1. Capital gains tax reduction: By realizing losses, you can offset capital gains and potentially lower your tax liability. Capital losses can be used to offset capital gains in the same tax year, and any excess losses can be carried forward to offset future gains.

  2. Portfolio optimization: Tax loss harvesting allows you to rebalance your portfolio while maintaining your desired asset allocation. It provides an opportunity to sell underperforming investments and replace them with similar investments, thereby maintaining your overall investment strategy.

  3. Tax-efficient investing: By strategically harvesting losses, you can minimize your taxable income and potentially move into a lower tax bracket. This can result in tax savings and improve the after-tax returns of your portfolio.

Things to consider before tax-loss harvesting a portfolio

  • Tax-loss harvesting can only be utilized in taxable accounts not in non-taxable accounts like 401(k)’s and IRA’s.
  •  Long-term losses are first applied to long term gains and short-term losses to short-term gains. If there are additional losses in either of these categories, they can be applied to gains of either type.
  • It’s important to ensure that you don’t trigger the IRS wash sale rule which disallows taxpayers from claiming a capital gain or loss if they own “substantially similar” security within 30 days before or after the sale. In this case the loss is not allowed.  

It is also important for investors to use caution when engaging in tax-loss harvesting as there are specific restrictions on how much one can deduct each year as well as limits on how long one may carry forward their losses into future years without incurring additional taxes or penalties. For 2023, if an investor doesn’t have gains to offset the losses they are allowed to take a $3,000 deduction to ordinary income. When taking losses, investors should be aware of what type of costs associated with selling investments such as transaction fees and commissions which may lower overall profits if not taken into account when performing your calculations.

Remember, tax loss harvesting should not be the sole driver of your investment decisions. It should be considered as part of a comprehensive investment and tax planning strategy.

Tax loss harvesting is a valuable tool for investors seeking to optimize their investment strategy while minimizing their tax liability. By understanding the concept, benefits, and implementation strategies, individuals can take advantage of this powerful tax-saving technique. Remember to consult with a tax professional or financial advisor to tailor tax loss harvesting to your specific circumstances and ensure compliance with applicable regulations. Start leveraging this strategy today to maximize your after-tax investment returns and work towards your financial goals.

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