As an investor, you make the conscious decision to take on the risks associated with investing. At the end of the day, this risk translates to some investments being “winners” and some being “losers”. Unfortunately, almost every investor will encounter these “loser” investments from time-to-time during their life. But not all hope is lost on these types of investments because you can actually use losses from an investment to help lower your tax liability. This is the tax-efficient strategy known as “Tax-Loss Harvesting”.
Tax-loss harvesting works as follows:
- You sell an investment that is not performing well at a loss.
- You reinvest this money from the sale in a different security that meets the investor needs and asset allocation strategy.
- When you file your tax return for that year, you can use the loss from the sale to offset any capital gains you had during the year. If the losses are greater than the gains for the year, you can offset the lesser of (1) the entire net capital loss for the year or (2) $3,000.
- If your net capital losses for the year are greater than $3,000, you will be able to roll the unused capital losses forward to future tax years to offset future gains.
Reducing your ordinary income by $3,000 might not sound like it would make a huge difference to the bottom-line tax liability, and you would be right in this assumption. However, where tax-loss harvesting can make a huge impact is for years following a market down year. This is because you can tax-loss harvest a larger amount of losses during the market down year and, while you likely will only be able to offset $3,000 of ordinary income for that specific year, you will be able to carryover larger amounts into the next year. These carryover losses can then offset a larger amount of gains that occur in subsequent years.
Being proactive and intentional about harvesting losses can save you money in the long run. This, in turn, will essentially boost your after-tax investment returns.
If you want to learn more about tax-loss harvesting, this article gives you a more detailed explanation of how and why tax-loss harvesting is effective.
https://www.cnbc.com/2022/12/26/how-to-take-advantage-of-tax-loss-harvesting.html