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Offsetting gains through tax-loss harvesting

Even in the storm clouds of investment losses, there's a silver lining.

POINTS TO KNOW

  • You're only taxed on net capital gains, so any realized losses will lower your tax bill.
  • The "tax-loss harvesting" strategy requires a little extra work on your part.

Facing hefty capital gains? Here's a potential solution

When you pay taxes on your realized capital gains for the year, you'll only consider your net gains—the amount you gained minus any investment losses you realized.

This means that if you know you're going to have some realized gains, it's a good idea to see whether you have any opportunities to realize losses to offset them.

For instance, if you need to rebalance your accounts, you could choose to sell shares of funds or stocks that have lost value since you purchased them.

This method of intentionally selling investments at a loss in order to lower taxes is known as "tax-loss harvesting."*

If your losses are greater than your gains

A year when your realized losses outweigh your gains is never fun, but you'll make up for a little of the pain at tax time. Up to $3,000 in net losses can be used to offset your ordinary income (including income from dividends or interest).

Note that you can also "carry forward" losses to future tax years.

Go in-depth ... Read our white paper on the potential benefits of tax-loss harvesting.

Watch out for the "wash sale rule"

The IRS won't allow you to sell an investment at a loss and then immediately repurchase it (known as a "wash sale") and still claim the loss.

If you buy the same investment or any investment the IRS considers "substantially identical" within 30 days before or after you sold at a loss, the loss will be disallowed. If you need guidance on whether an investment would be considered substantially identical, consult a tax advisor.

Want to keep tax-loss harvesting as an option?

To use tax-loss harvesting as a strategy, you must identify specific lots of shares to sell. And since your investment company reports information on your gains and losses on covered securities to the IRS,** it's important that everyone's on the same page about which shares are being sold.

This means you'll need to use the "specific identification" cost basis method when you sell shares. It's more work for you, but results in greater flexibility to offset taxes.


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REFERENCE CONTENT

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Realized gains

Capital gains that are now taxable because the investment has been sold at a higher purchase price than what was originally paid.

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Capital gain

An increase in the value of an investment over the initial purchase price. A capital gain is "unrealized" until the investment is sold, when it becomes a realized gain. Realized gains are taxable and they may be considered short-term (if the investment was owned one year or less) or long-term (if the investment was owned for more than one year).

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Rebalance

To move money in your account so that your overall portfolio aligns with the asset mix you selected, usually after market movements have caused it to change.

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Stock

Usually refers to common stock, which is an investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.

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Dividend

The distribution of the interest or income produced by a fund's holdings to its shareholders, or a payment of cash or stock from a company's earnings to each stockholder.

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Interest

Income you can receive by investing in bonds or cash investments. The investment's interest rate is specified when it's issued.

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Lot

Shares acquired in one transaction. You can own multiple lots of an investment if you acquired shares of the same security at different times.

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Share

A single unit of ownership in a mutual fund or an exchange-traded fund (ETF) or, for stocks, a corporation.

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Cost basis

The original cost of an investment (adjusted for commissions or capital distributions). For tax purposes, the cost basis is subtracted from the investment's value at the time of sale, minus fees and commissions, to determine any capital gain or loss.