Tax Loss Harvesting

| May 01, 2017
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When investing your money, there will be times when you will have positions with a loss – it’s inevitable. The good news?  There is a powerful tax strategy that you can use called loss harvesting. This strategy applies to investments in taxable accounts (but not IRA or 401k retirement accounts).

A disadvantage with taxable accounts, is that if you sell an investment with a gain, you will have to pay taxes on that gain for that year. This is called a realized gain. As mentioned earlier, an advantage of a taxable accounts is that if you have any losses in the same year, you can use them to offset the realized gains and help lower your tax bill for that year.

You have to sell the stock at a loss, and when you do this, it is called a realized loss. You can then use the realized losses from positions that are down to offset the realized gains from positions that are up.

There is a rule you must navigate around called the “Wash Sale Rule”. This rule states that if you sell an investment to generate a realized loss for taxes, you must wait 31 days before buying back into that same investment or something “substantially identical”, or else the loss is disallowed. After 31 days are up, you can buy it back again. You are allowed to buy a similar investment during the 31 days, but not the same investment or anything “substantially identical” to it within the 31 days.

Another helpful thing about this tax strategy is that if you have more losses than gains for a particular year, you can carry forward the excess losses and use them against future gains, and up to $3,000 in ordinary income. In years when you may not have gains, you’re still allowed to deduct $3,000 of these losses against ordinary income each year going into the future until those losses are used up. 

Here’s an example from a client we did this for. To make it easy - say you only have 2 positions in your account for sake of simplicity. One investment is up $7,000 and the other investment is down $10,000. We had them sell the investment that was down and put that money into something else. We locked in a $10,000 capital loss for taxes. When we sold the investment that was up $7,000, we used the $7,000 of the $10,000 loss that you have to offset the $7,000 gain and you would still have $3,000 left over, in my example, to apply to ordinary income. The net result is not only did you not pay any taxes on the investment that had gains on it, but you also were able to deduct $3,000 of the losses against your ordinary income, saving you another $750 (assuming 25% tax bracked).

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

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