Tax Loss Harvesting

Want to impress your friends with knowledge of reducing your taxes using investment sales? I’m going to teach you.

We all know the adage, “buy low, sell high.” Well, sometimes your investments don’t turn out the way you want them to, and you may want to consider selling low. Tax loss harvesting is when you sell a security (e.g., stock, bond, etc.) that has a loss, meaning, you bought it at one price, and it went down in value. When you sell, you “realize” the loss. This can potentially reduce your taxes, since investment losses are deductible.

One would typically sell a security to realize the loss, then use the proceeds to invest in something similar, but not TOO similar. You want to keep your money invested and working for you; however, the “wash-sale rule” disallows the loss from your tax return, if you buy back the same or a very similar security within 30 days.

Let’s use numbers to spell this out further.

Let’s say I own Apple stock. Pretend there is some magical universe where Apple’s share price drops. I bought it at $80/share, and it dropped in value to $60/share. I know, ridiculous.

I decide that I want to sell the stock to realize the loss of $2,000, because I really want that loss for my tax return to reduce my income. I sell the stock on 12/15/21 and boom, $2,000 loss for my taxes.

However, if I foolishly buy 1,000 shares of Apple stock within 30 days, I will not get to deduct the loss on my tax returns. Instead, it will be added to the cost basis again.

 I can re-buy the Apple stock after 31 days without violating the wash-sale rule.

Why would someone engage in tax loss harvesting?

Well, taking a tax deduction helps you to lessen the pain of having lost money in the stock market. If you are going to re-buy the security anyway, and are in it for the long-term, you can defer any gains until the future. It is important to note that tax loss harvesting only defers income taxes, because when you rebuy the security, you are potentially kicking the can down the road to pay tax on the gain from the new purchase.

Also, you may want to offset some of the gains in your investments. You can use capital losses, that you get from tax loss harvesting, to offset capital gains. Any additional loss, above and beyond the amount of your gains can be deducted against ordinary income, up to $3,000 per year, and can be carried
forward indefinitely.

We might need a numerical example for this.

Let’s say I own an investment in my taxable account, and it has paid out $5,000 of capital gains. If I use the above example with Apple stock, and take the loss of $2,000, I can count that against my gains, and now have a NET gain of only $3,000 to pay taxes on.

Now let’s say instead I have only $500 of gains for the year. If I use my $2,000 loss, I can offset my entire gain, and still have a NET loss of $1,500 to apply towards the rest of my taxable income.

It is important to approach tax loss harvesting with caution. If you don’t quite understand how this all works, be sure to ask your wealth advisor to help.

As always, if you still have questions, feel free to email me.

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