Introduction
Tax season. It's the time of year that can bring both excitement (hello, refunds!) and dread (especially if you owe). While we can't eliminate taxes altogether, there are smart strategies to potentially lower your tax bill. One such strategy, often overlooked but incredibly powerful, is tax-loss harvesting.
Tax-loss harvesting allows you to offset capital gains—profits made from selling assets like stocks or bonds—with capital losses. Essentially, it's about strategically selling investments that have lost value to reduce your overall tax liability.
Understanding Capital Gains and Losses
Before diving into the specifics of tax-loss harvesting, it's crucial to grasp the concepts of capital gains and losses.
- Capital Gain: A capital gain occurs when you sell an asset for more than you paid for it. For example, if you bought a stock for $50 per share and sold it for $75 per share, you'd have a $25 per share capital gain.
- Capital Loss: A capital loss is the opposite—selling an asset for less than its original purchase price. Using the same stock example, if you sold it for $30 per share, you'd experience a $20 per share capital loss.
How Tax-Loss Harvesting Works
Tax-loss harvesting involves selling investments that have experienced a loss. Here's a step-by-step breakdown:
- Identify Losing Investments: Review your portfolio and pinpoint investments that are currently valued at less than their purchase price.
- Sell Losing Investments: Sell the chosen investments to realize the capital loss.
- Offset Capital Gains: Use the realized capital losses to offset any capital gains you've made during the tax year.
- Offset Ordinary Income: If your capital losses exceed your capital gains, you can use up to $3,000 of those losses to offset your ordinary income (income from wages, salaries, etc.).
- Carry Forward Losses: If you have losses exceeding the $3,000 limit, you can carry forward those losses to future tax years.
Important Considerations
- Wash-Sale Rule: Be mindful of the wash-sale rule, which prevents you from claiming a loss if you repurchase the same or a "substantially identical" security within 30 days before or after the sale.
- Long-Term Investment Strategy: Tax-loss harvesting should align with your overall investment goals. Don't let tax benefits drive you to make investment decisions that don't fit your long-term strategy.
- Seek Professional Advice: Consult with a qualified financial advisor or tax professional to determine if tax-loss harvesting is right for your specific financial situation.
