Sometimes we lose, sometimes we win, and most of us experience both in the same year if our financial portfolios are diverse enough. Tax loss harvesting can be a useful tax tool in these situations.
Tax loss harvesting involves selling an investment that has lost value to offset capital or taxable income gains that have been or will be utilized in the same year in other areas. You may have heard the term thrown around more than usual in 2022, which was an extra volatile year for investments. However, the stock market or you individually do not need to have experienced extreme losses or gains to benefit from take loss harvesting. On the contrary, only $3,000 of a capital loss carry forward ($1,500 for single filers) can be used to offset gains each year. It’s not a life-changing amount, but it’s beneficial.
You can also carry excess losses forward yearly to offset future gains, making it a tax gift that keeps giving. Bear in mind that these rules apply to individuals, not businesses. Businesses can carry forward losses, too (including net operating losses), but restrictions differ.
Before you jump into tax loss harvesting, be sure your tax and investment advisors are on the same page. For it to truly benefit you, your use of tax loss harvesting must align with your broader, long-term asset management goals. Also, be sure to understand:
- The “wash sale” rule. This rule prevents you from repurchasing the same or a substantially identical investment within 30 days of selling it at a loss.
- The long-term value of the stock you’re about to sell. Temporary dips may not make a big difference in the long run. In other words, think twice about selling good investments for tax purposes. You may be able to offset gains in other ways.
- What you can and cannot sell to qualify for tax loss harvesting. It’s not limited to stock investments. Sales of exchange-traded funds (ETFs), mutual funds, cryptocurrencies, or even real estate investment trusts (REITs) may qualify but check with an advisor.
- The difference between a long-term and a short-term capital gain or loss. Assets held for less than one year are generally considered short-term and taxed at ordinary income rates, while assets held over one year are taxed at a more favorable long-term rate.
Ultimately, tax loss harvesting is just one tool in a comprehensive financial strategy, and its effectiveness depends on individual circumstances and thoughtful implementation, but it can be worth considering. Feel free to contact us with questions.
