Tax-loss harvesting
is an investment strategy designed to minimize taxes on capital gains by offsetting gains with investment losses. Here’s how it typically works:
1. Identifying Losses:
Investors review their investment portfolio to identify securities that have decreased in value since their purchase.
2. Selling Underperforming Assets:
The investor sells these underperforming assets, realizing a capital loss on the investments.
3. Offsetting Gains:
The capital losses are then used to offset capital gains realized elsewhere in the portfolio. By doing so, investors can reduce their overall taxable capital gains for the year.
4. Offsetting Income:
If the total capital losses exceed the capital gains, investors can use up to $3,000 of the remaining losses to offset other types of income, such as wages or dividends, for federal income tax purposes.
5. Carrying Forward Losses:
If the total losses exceed both capital gains and allowable deductions, the remaining losses can be carried forward to offset gains in future years.
It’s important to note that tax-loss harvesting is a strategy primarily used for taxable investment accounts, as tax implications in tax-advantaged accounts like IRAs or 401(k)s are different. Additionally, to comply with tax regulations, investors need to be mindful of the “wash sale” rule, which prohibits repurchasing a substantially identical security within 30 days before or after the sale.
While tax-loss harvesting can be an effective way to reduce tax liability, it should be done with consideration for the investor’s overall financial goals and investment strategy. It’s advisable to consult with a tax professional or financial advisor to ensure that the strategy aligns with the investor’s specific circumstances and objectives.
To delve deeper into the intricacies of tax-loss harvesting, you can check out this insightful article on the CFA Institute’s blog: Tax-Loss Harvesting: Should Investors Believe the Hype?.
