Tax Strategy: Tax Loss Harvesting

What is tax loss harvesting?

Investments, like stocks, are subject to a capital gains tax, which can be taxed at a rate of up to 20%, depending on the filer’s income bracket. Short-term capital gains — i.e. investments sold that you have owned for less than a year — are taxed as ordinary income. For high earners, this is an even higher rate than the long-term capital gains tax.

Tax loss harvesting is a tax strategy investors use to offset some of the gains realized on the sale of a profitable stock, while still maintaining the overall value of their portfolio.

Here’s how tax loss harvesting works:

1. You sell an underperforming stock at a loss.
2. Up to $3,000 of that loss (per year) can be used to offset your gain. If the loss is greater than that limitation, you can carry the balance of the loss into future years, deducting up to $3,000 each year.
3. You then reinvest the funds from the sale of the underperforming stock back into a different stock option in order to rebalance your portfolio.

Tax loss harvesting can take place at any time of the year, but waiting until the end of the year during tax planning allows you to assess current portfolio performance and tax implications.

What about the wash-sale rule?

The wash-sale rule prohibits you from selling an investment at a loss for tax benefits, only to repurchase the same — or “substantially identical” — stock.

This rule requires a 30-day waiting period to purchase the same (or substantially identical) security both before and after the sale of the underperforming stock. This equals a full 61-day window.

Keep in mind this waiting period isn’t confined to a particular calendar year, so a stock sold on December 23 can’t be repurchased on January 5 without violating the wash-sale rule.

The wash-sale rule doesn’t only apply to your own investment accounts (yes, this includes your retirement accounts). It also applies to a spouse’s investment accounts, as well, when filing jointly.