How tax loss harvesting works
Tax loss harvesting is a strategy used by investors to offset taxes by selling securities that have lost value. It may sound complicated, but it’s actually quite simple! In this post, we’ll dive into the basics of how tax loss harvesting works, and explain why it’s a smart move for savvy investors.
How tax loss harvesting works
What is a tax loss?
First things first: what is a tax loss? Simply put, a tax loss occurs when you sell an investment for less than you paid for it. This could happen for a variety of reasons, such as market fluctuations or a change in the company’s financial situation. When you have a tax loss, you can use it to offset the taxes you owe on gains from other investments.
Example
Here’s an example: let’s say you bought 100 shares of Acme Corporation for $50 per share, for a total investment of $5,000. Later, the market value of Acme drops to $30 per share, so you decide to sell your shares. You now have a tax loss of $20 per share, or $2,000 total. If you had another investment that had gained $2,000 in value, you could use the tax loss from Acme to offset the taxes you’d owe on the gain from the other investment.
So, how does tax loss harvesting work in practice? It’s all about timing. You want to sell your losing investments strategically, so you can use the tax losses to your advantage. There are a few different ways to do this:
Sell at the end of the year:
Many investors wait until the end of the calendar year to sell losing investments. This gives them a chance to see which investments have lost value, and how much of a tax loss they have. It also allows them to offset gains from other investments they’ve sold throughout the year.
Use the 30-day rule:
The IRS has a rule that says if you sell a security for a loss, you can’t buy the same or a substantially identical security within 30 days before or after the sale.
This is to prevent investors from “washing” losses and gains by quickly buying and selling the same security. However, you can buy a similar security or a security in the same industry to maintain your portfolio’s balance.
Keep an eye on your portfolio:
If you’re actively managing your investments, you should always be aware of which securities are gaining and which are losing. By keeping track of your portfolio’s performance, you can identify opportunities to sell losing investments and harvest tax losses.
Isn’t a magic bullet
One thing to keep in mind is that tax loss harvesting isn’t a magic bullet. It won’t eliminate your tax bill entirely, but it can help reduce it. Additionally, you shouldn’t let the tax tail wag the investment dog. In other words, don’t sell an investment solely for tax purposes if it doesn’t make sense from an investment standpoint.
A smart move for savvy investors
Now that we’ve covered the basics of tax loss harvesting, let’s talk about why it’s a smart move for savvy investors. First and foremost, it can help reduce your taxes. By offsetting gains with losses, you’ll owe less in taxes overall. Additionally, tax loss harvesting can help you maintain your portfolio’s balance and reduce your risk.
If you have multiple losing investments, selling them and reinvesting in other securities can help diversify your portfolio and protect against further losses.
Conclusion
In conclusion, tax loss harvesting is a powerful tool in any investor’s arsenal. By strategically selling losing investments and using the tax losses to offset gains, you can reduce your taxes and maintain a well-balanced portfolio. Just remember to keep an eye on your investments and don’t let the tax tail wag the investment dog!
Here is a super short version What’s tax harvesting
