Tax Loss Harvesting is an investment strategy that allows an investor to turn lemons into lemonade! If (or when) you experience losses in your portfolio, you can sell the non-performing investments and deduct the loss against current or future gains.
For example, if you sell “Investment A” for a gain of $1,000 and you are in the 35% tax bracket, you will owe $350 in capital gain taxes.
If you take advantage of Tax Loss Harvesting you could still sell “Investment A” for a $1,000 gain, but you might also sell “Stock B” for a $1,000 loss. The gains and losses offset each other and you don’t pay taxes, or better said you save $350 in taxes.
Ok, so why sell either one? I can do nothing and save $350 in taxes. There are a few reasons you might sell:
- Take the loss as a way of offsetting taxes from gains on sales of other assets or even ordinary income (the loss can even be used to offset future gains!).
- Tax Loss Harvesting allows you to rebalance your portfolio in a tax efficient manner
- Increasing your cost basis. Cost basis is simply the price you pay for an investment. Utilizing Tax Loss Harvesting you can increase the cost of your assets so when you sell at a future date, you show less gains to pay taxes on.
It’s important to note that this strategy only works in non-qualified investment accounts (“qualified” retirement accounts like IRA’s or 401(k)’s are not subject to capital gains taxes). Tax loss harvesting should only be performed by or with your financial professional. You will want to avoid the Wash-Sale Rule and ensure that you do not exceed your tax liability. Finally, Tax Loss Harvesting should also fit into your overall investment strategy.