Tax Loss Harvesting: What You Need to Know

At the end of the calendar year, investors are frequently flooded with suggestions for smart year-end moves. Invariably, high on the list of strategies to consider is tax-loss harvesting. Unfortunately, these lists tend to leave out essential details investors should know.

Have no fear. The Shared Vision Wealth Group has created this helpful beginner’s guide to fill in the gaps on this critical topic.

What Is Tax-Loss Harvesting?

Tax-loss harvesting is a strategy in which investments in your portfolio that have declined in value are sold to generate capital losses.

Those losses can then offset capital gains from your portfolio (from selling investments that have appreciated or capital gain distributions) or up to $3,000 in taxable income in a given year. Alternatively, they can be carried over into the future if you have more losses than gains or income that year.

Potential Benefits of Tax-Loss Harvesting

One of the primary benefits of tax-loss harvesting is its potential to help you reduce your tax bill, especially if you realize enough losses to use against short-term capital gains or regular income (as those tax rates typically are higher than on long-term capital gains).

Furthermore, research suggests that a thoughtful long-term tax-loss harvesting strategy can generate potentially higher net after-tax returns for your portfolio.

How Tax-Loss Harvesting Works

The basic steps in tax-loss harvesting are as follows:

1. Identify the investments that have lost value (both short and long-term) and are candidates to sell and harvest losses
2. Sell the investments and use the losses to offset capital gains or income on your tax return
3. Reinvest the money (see note on wash sale rule below)

Despite its simplicity, tax-loss harvesting can be a useful money-saving strategy for savvy investors.

Risks and Common Mistakes of Tax-Loss Harvesting

While the concept of tax-loss harvesting is relatively straightforward, there are some critical details worth examining if you want to avoid common mistakes and reap the full benefit of the practice.

Matching Short-Term vs. Long-Term Capital Gains/Losses

If you’ve only been investing for a year or less, the gain/loss would be categorized as “short-term”; if you’ve held it for over a year, it would be considered “long-term.”

Tax-loss harvesting can be used to offset either kind of gain, but only after first being applied to investment gains in the same category. If you only have long-term losses but both long- and short-term gains, you must use the long-term losses against the long-term gains before any excess losses can offset short-term gains.

Tax-Deferred Accounts

Tax-loss harvesting only works for taxable accounts. It’s not a helpful strategy for your 401(k) or IRA, as you can’t deduct losses from a tax-deferred account.

The Wash-Sale Rule

When you engage in tax-loss harvesting, you’re selling investments and going to cash. This can change your asset allocation and take you “out of the market,” something many investors aren’t keen on if things are going up.

You can immediately reinvest that money, of course. However, you should be aware of the IRS regulation prohibiting investors from using a security for a capital loss purchased within 60 days of generating the loss.

This means that for the 30 days before realizing a loss and the 30 days after, you can’t buy a “substantially identical” security.

Making Tax-Loss Harvesting Work for You

Tax-loss harvesting can be a valuable strategy, but it can also be complicated — and even risky — if you don’t go about it correctly. If you have questions, get help from the experienced team of dedicated advisors at Shared Vision Wealth Group. Contact us today to schedule a consultation.

This material is for informational purposes only and is not a recommendation or advice for your individual portfolio. Shared Vision Wealth Group does not provide tax or legal advice. Consult a tax professional or attorney licensed to practice law in your state regarding your specific situation.