Home > Personal Finance > Tax-Loss Harvesting: What the Heck Is That?

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While investing can help you build wealth, taxes can really take a toll on your earnings. Savvy investors know that the value of securities go up and down after being purchased. Paying diligent attention to your taxes and using losing picks to reduce your tax bill can help keep more money in your pocket.

Tax-loss harvesting is the act of capturing downturns in the market to reduce what you owe in taxes. By selling stocks or other assets that have lost value, you can experience a reduction in your tax liability that you can use to offset any capital gains tax you may owe.

It can not only reduce your investment tax bill, but also reduce your overall tax bill as you can use up to $3,000 of tax losses to reduce other taxable income and reduce future tax bills. This is because you can roll over old, unused harvest losses.

How It Works

Your portfolio probably already contains some tax losses that can be harvested to reduce this year’s or future tax bills. If you plan to offset a portion of your capital gains with these losses, you will need your tax lot and cost basis (price you paid to purchase a security plus any additional broker fee or commission fees) information.

Determine whether your gains and losses are short- or long-term. The size of your savings depends on your income level and the amount of your short- and long-term capital gains, as well as any current losses you have already realized.

The higher your tax bracket, the greater the potential for tax-loss harvesting savings. The best you can do is keep good records of your assets year-round to help you track your cost basis and locate any capital gains tax liability.

What You Should Know

While selling investment losses can be a good move, it’s important to not undermine long-term investment goals just for tax-saving purposes. For example, if you are investing money to save up for specific financial goals (retirement, buying a home, etc.), you don’t necessarily want to sell those investments and jeopardize reaching your goals to avoid paying some taxes this year.

The best candidates for tax-loss harvesting are depreciated investments that do not fit your investment strategy anymore, have poor growth potential, or can be replaced by other similar investments. It’s also a good idea to beware of the wash sale rule, a restriction that the Internal Revenue Service enacted to limit irresponsible use of capital losses for tax benefits. Investors must wait at least 31 days before buying back either the same or any like-kind security and then stating a loss.

You can always visit the IRS website or consult your financial adviser for more information about how capital gains and losses are computed and how to minimize your taxable investment income. There are now even robo-advisers, or computer programs that perform automated money management services that can help you take advantage of tax-loss harvesting and portfolio balancing without requiring you to take any action. (It’s a good idea to properly vet any service or company you are considering before you move to use it.)

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