Right now is a good time to make sure you’ve done all you can to minimize your tax burden for the year. Tax-loss harvesting is one common strategy to consider.

Did your portfolio suffer an investment loss this year? You just might be able to make lemonade out of those lemons with an investment strategy called tax-loss harvesting.

What is tax-loss harvesting?

Essentially, this strategy involves using a loss to offset your tax liability and shift your portfolio toward an improved position.

Here’s how it generally works: You sell (or “harvest”) an underperforming investment at a loss, then use that money to reinvest in a different security. You can then use those realized losses to offset up to $3,000 of ordinary income and thereby reduce your taxable capital gains for the year.

The outcome is that fewer of your dollars go to taxes, while you’re able to keep more working for you. You’re also able to carry losses forward indefinitely, helping you reduce taxes now as well as in the future.

There are other times when you may want to implement tax-loss harvesting, not just when you’ve had a bad investment year or there’s been a market downturn:

  • You have a lot of capital gains: If you sold an investment for a big return, you may want to look at what can be sold at a loss to offset the taxable income from those gains.
  • You anticipate being in a lower tax bracket in the years to come.
  • You invest in EFTs or individual stocks, rather than solely in mutual funds.

What are the rules?

There are a number of things to be aware of when it comes to offsetting gains with harvested losses.

Tax-loss harvesting is only applicable to taxable investment accounts. 

You can’t apply this strategy to your 401(k) or other tax-deferred retirement accounts, like 403(b)s, IRAs and 529 accounts. You can only use tax-loss harvesting (and you only need to use it) on taxable gains.

There’s a deadline for harvesting your loss.

You must complete all harvesting for 2021 taxes before the calendar year is up, December 31.

There’s a tax difference between short-term and long-term capital gains and losses.

The two are taxed differently. While short-term capital gains are taxed at your marginal tax rate as ordinary income, a different tax rate applies to long-term capital gains. There are also rules about harvesting and applying the losses. Discuss these with your tax advisor.

Be aware of wash sale rules.

A wash sale is when you sell a security and then repurchase the same or what the IRS refers to as a “substantially identical” security within 30 days before or after the sale. These can have costly tax consequences, and the IRS will consider transactions as wash sales even if you repurchase the security in a different account or in your spouse’s name.

Think about your investment goals first. 

Realizing tax savings in a given year and over the long term is important, but it’s just part of your larger retirement planning picture. If you decide to implement tax-loss harvesting, make sure it’s in line with your financial plan.

As with any investment strategy, it’s important to know that tax-loss harvesting doesn’t make sense for every investor and every situation. Always consult with your tax advisor and wealth manager to determine the best course for you.

Do you want to find out if tax-loss harvesting is a good strategy for you? Our tax services and strategies are another way we bring you personal, professional service. Learn more and contact us today.