Year-end is near, and that means it’s time for those last-minute moves to trim your tax bill. If you traded securities during 2024, tax-loss harvesting may help you lower your tax liability and save money. Let’s explore what you need to know with eight expert-informed tax-loss harvesting tips.
Understanding Tax-Loss Harvesting
Tax-loss harvesting is a strategy to reduce capital gains taxes. Done right, tax-loss harvesting has short- and long-term wealth benefits. Read on to find out what this strategy entails and how it works.
What Is Tax-Loss Harvesting?
Tax-loss harvesting involves intentionally selling securities or cryptocurrency for less than you paid for it. You then use the losses to offset taxable gains realized in the same tax year. The maximum loss you can claim in a year is equal to your realized gains plus $3,000. The losses you take will offset your gains, and the excess $3,000 can reduce your taxable ordinary income.
Any losses remaining—after offsetting your gains and reducing $3,000 of ordinary income—can be used in future tax years. Losses carried forward do not expire.
Tax-loss harvesting is legal, but there is a major caveat. The IRS will disallow your loss as a deduction if you repurchase the same or substantially identical security within 30 days. This is known as the wash-sale rule. Note that the wash-sale rule applies to securities only and not cryptocurrency.
How Tax-Loss Harvesting Works
The first step of tax-loss harvesting is to review your portfolio and add up the taxable gains you need to offset. If you have $5,000 in gains, you could use up to $8,000 in losses—assuming you earned at least $3,000 in ordinary income this year.
Next, if you don’t have unused losses from prior years, review your holdings to identify new loss targets. Look for positions you can sell without disrupting your investment or tax strategies, such as:
- Securities that are not important, long-term holdings. The wash-sale rule prohibits you from purchasing the same security, so you shouldn’t sell anything important.
- Securities that can be replaced with something better that will provide similar exposure. Tax-loss harvesting should not take priority over your asset allocation strategy.
- Securities that are not recently purchased qualified dividend stocks. Qualified dividends are taxed at the lower capital gains rates, while unqualified dividends are taxed at higher ordinary income tax rates. To realize the lower qualified dividend tax rate, you must hold the stock for at least 61 days within the 121-day period that begins 60 days before the ex-dividend date. Selling an income stock prematurely to harvest a loss can raise your dividend taxes, which would be counterproductive.
Once you pick appropriate loss targets, sell the losing positions within the same tax year. You can then use the losses to offset your gains on your tax return for that year.
Much more than breaking news, our diverse reporting digs deeper with unparalleled insights that empower you to make better informed decisions. Become a Forbes member and get unlimited access to cutting-edge strategies, actionable insights, and updated analysis from our network of leading finance experts. Unlock Premium Access — Free For 25 Days.
Who Should Use Tax-Loss Harvesting?
Tax-loss harvesting can benefit any investor who has realized taxable capital gains in the tax year. Capital gains can arise from maintenance actions within your portfolio, such as rebalancing and profit-taking.
Capital gains can also result from more complex situations. Judson Gee, managing partner at JHG Financial Advisors, has worked with investors who are over-concentrated in assets that have a very low cost basis. This can result from a gift or the receipt of Restricted Stock Units as employee compensation. A strategic tax-loss harvesting effort can reduce the cost of restructuring or liquidating those assets.
Gee points out that because tax-loss harvesting can offset ordinary income, taxpayers in high tax brackets and high-tax states may benefit most.
8 Top Tax-Loss Harvesting Tips
Use the eight tax-loss harvesting tips below to avoid common mistakes and maximize your tax benefit.
Know The Nuances Of The Wash Sale Rule
The wash-sale rule sounds simple at first: Do not repurchase a security you have sold if you intend to deduct the loss. But nuances of the rule add complexity. Colleen Carcone, Director of Wealth Planning Strategies at TIAA, clarifies:
- Your spouse’s trading activity counts. If you sell the security and your spouse repurchases it, that loss cannot be deducted.
- The window is 30 days before or after the trade. The wash-sale rule considers purchases made before and after the loss is realized.
- Purchasing substantially identical securities will trigger the wash-sale rule. If you want to deduct a loss on, say, an S&P 500 index fund, you cannot purchase a different S&P 500 index fund within the restricted window.
- The wash-sale rule covers all your accounts. Carcone explains, “You can’t sell an asset at a loss in a taxable account and then purchase that same security (or a substantially identical one) in your retirement account.”
The rule also prohibits you from claiming a deduction if you buy options to purchase a substantially identical security.
Consider The Risks Of Tax-Loss Harvesting
Tax-loss harvesting is not always the right strategy. As Carcone explains, selling assets “may change the overall risk associated with your portfolio and your expected returns.” Those changes can impact your ability to reach your financial goals. Undermining your long-term financial plan to trim your tax bill is likely counterproductive.
Review All Available Tax Lots For Your Positions
Brian Tullio, wealth manager at Fairway Wealth Management LLC, recommends looking at the tax lots of your positions to identify loss opportunities.
A tax lot is a single transaction of shares purchased. Each lot can have an unrealized gain or loss, which could be different from your net position on the same security. To demonstrate, let’s assume you have spent $1,125 purchasing 100 shares of ABC stock over four transactions. If ABC is trading at $13, you have a net unrealized gain of $175.
However, when you review your purchases of ABC, you see that one lot is in a loss position:
- 25 shares at $10 each
- 25 shares at $15 each
- 25 shares at $8 each
- 25 shares at $12 each
Because tax law allows you to specify which shares you are selling, you could liquidate 25 shares from the second tax lot above to create a loss.
Discover more in-depth insights, entrepreneurial advice and winning strategies that can propel your journey forward and save you from making costly mistakes. Elevate your journey by becoming a Forbes member. Unlock Premium Access — Free For 25 Days.
Focus On Short-Term Gains And Losses
Short-term capital gains and long-term capital gains have different tax rates. Short-term capital gains are realized by selling investments you owned for one year or less. These gains are taxed as ordinary income at your marginal tax rate. In 2024, the highest marginal tax rate is 37%.
Long-term capital gains arise onsecurities you owned for longer than one year. Your tax liability on long-term capital gains is either 0%, 15% or 20%, depending on your income.
Because of the higher tax rate on short-term gains, Mark Luscombe, principal analyst at Wolters Kluwer, recommends focusing there first. “It is more efficient to offset a short-term capital gain with a short-term capital loss than to create a capital loss to offset a long-term capital gain,” Luscombe explains.
Remember Unused Losses From Prior Years
You can offset gains this year with older losses. Before incurring new losses, verify that you have used all available losses from prior years.
Consider Accumulating Losses Strategically
If you have losses and no gains this year, consider whether you will benefit more from realizing a gain now or saving the losses to use later. According to Tullio, carrying forward the losses is wise if your income is low today, and you expect to realize larger capital gains in the future.
Let’s say you plan on liquidating a sizable chunk of your portfolio to buy a home or fund a child’s college tuition. A major liquidation like that could raise your income, potentially moving you to the highest capital gains bracket of 20%. Carrying forward losses in that scenario could allow you to offset a 20% tax liability later—versus 0% or 15% this year.
Reinvest Tax Savings
Capital gains taxes reduce the funding available for your investment account going forward. Loss harvesting can help you recapture those tax dollars. Reinvesting those funds maximizes your benefit. Over time, the reinvested funds can grow and compound, allowing you to reach your financial goals faster.
Work With Your Advisors
Tax-loss harvesting is complicated and the potential for mistakes is high. Jessica Wheaton, CPA and tax and accounting services director at Fiske & Company, recommends working closely with your tax and financial advisors to avoid unintentional problems. Your tax advisor can estimate your gains for this year and inform you of any loss carryforwards you have available. Your financial advisor can identify strategies for loss harvesting that will not upset your financial plan.
Carcone seconds this opinion. “Professional guidance can help ensure that changes align with your long-term goals and risk tolerance,” Carcone explains.
Bottom Line
Done right, tax-loss harvesting can lower your tax bill now and increase your wealth later. The strategy does require expertise and careful planning, however. Working with an advisor may be your best option for lowering your tax bill while staying on track financially.
Read Next
Please note that I am not a registered investment advisor and readers should do their own due diligence before investing in this or any other stock/ETF. I am not responsible for the investment decisions made by individuals after reading this article. Readers are asked not to rely on the opinions and analysis expressed in the article and encouraged to do their own research before investing.
Read the full article here
