What is Tax-Loss Harvesting? How can I Turn Investment Losses Into Tax Savings?

It is that time of the year again, the days are getting shorter and the workload for accountants around the country is getting heavier.  Tax season is just a couple of months away, and time is limited to make some last-minute moves to lower that tax bill.  One such strategy is called tax-loss harvesting, investments that are in the red could be your ticket to a lower tax bill.

Sell losing investment positions and buy a tax break:

Many taxpayers think that “tax shelters” are just for the rich. Tax-loss harvesting helps everyday investors minimize what they pay in capital gains taxes by offsetting the amount they are required to claim as income.

You “harvest” investments to sell at a loss, then use that loss to lower or even eliminate the taxes you have to pay on gains you made during the year.  Taxpayers who don’t have investment gains to minimize can use the losses to offset the taxes they pay on their ordinary income instead.

First, a word of caution:

There are rules that you must be aware of prior to utilizing this strategy:

One such rule is called “Wash sale Rules”:  If within 30 days of selling the investment (either before or after) you or your spouse invests in something that is identical or, in the IRS’ words, “substantially similar” to the one you sold then your loss will be disallowed.

Another detail to be aware of is the type of account you are harvesting losses from.  Because retirement accounts such as IRAs, 401(k) and SIMPLE IRAs are tax deferred accounts, trying to harvest losses from these accounts will not work.

As with any important tax decision, please contact us prior to harvesting losses, it is possible for a taxpayer attempting to lower his tax burden to actually increase his tax liability through misunderstanding of the tax code.

Just because you can, does not necessarily mean you should.

Since the idea behind tax-loss harvesting is to lower your tax bill today, it is most beneficial for people who are currently in the higher tax brackets. In other words, the higher your income tax bracket, the bigger your savings.

If you’re currently in a lower tax bracket and expect to be in a higher tax bracket in the future, you might want to save the tax-harvesting until later when you’ll reap more benefits from the strategy.

If you are going for it, you have only until December 31

Procrastinators take note: Some strategies, such as opening and funding an IRA, can be made up until the April tax filing deadline. However, there is no such grace period for tax-loss harvesting.  You need to complete all of your harvesting before the end of the calendar year, December 31.

There are limitations to how much the IRS will let you deduct:

Capital losses must first be used to offset any capital gains you realized during the year. If you have more losses than gains can you use the losses as a write-off against your other income.  You can use a maximum of $3,000 of capital losses each year as a write-off against income other than capital gains. If your losses are greater than your gains by more than $3,000, the extra losses above the $3,000 limit can be carried forward to future tax years. In the next tax year, the carry forward loss would again be first used against capital gains, and another $3,000 of excess would reduce other income.

There is no one-size-fits-all approach to tax planning:

This strategy may or may not be beneficial to you.  As always, our goal is to partner with you and work together in making your financial story a true success.  If you were fortune enough to be on the receiving end of a large capital gain, and you are in a high tax bracket tax loss harvesting may be something you’d like to discuss with us before the end of the year.