You’re ready for any market with tax-loss harvesting

Tax-loss harvesting offers a way to save more

Tax-loss harvesting is a strategy that helps you minimize your tax burden. It works to reduce your capital gains taxes by using realized losses to offset realized gains and allows you to stay fully invested and aligned with your investing strategy. Best of all, the money you save on your taxes can be reinvested, giving you the chance to increase the value of your savings.

It’s a silver lining during downturns

While market ups and downs are a normal part of investing, it’s never easy to watch your investments lose value. With tax-loss harvesting, you can turn down markets into an opportunity, because it’s about using investment losses to help lower your tax bill for the year.

Think of it as a silver lining during periods of uncertainty—it’s there to bring you more value when markets are volatile and give you some control over when and how much you’ll pay in taxes.

How tax-loss harvesting works

If you have any realized capital gains for the year, you can take advantage of tax-loss harvesting.

First, you’ll seek to offset your gains by intentionally selling securities from one of your taxable accounts at a loss and reinvesting the money in a similar investment or rebalancing, if needed. It’s important to be aware of the IRS wash-sale rule when reinvesting the funds. 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, you won’t be able to claim the loss.

Then you can use your realized losses to offset any capital gains that occurred during the same tax year, plus up to $3,000 of ordinary income ($1,500 if you’re married, filing separately). You can also carry forward any remaining losses indefinitely to help offset gains and $3,000 of income in future tax years.

At tax time, you can reinvest your tax savings. While this optional step isn’t part of tax-loss harvesting, it’s a good way to put more of your money—and the power of compounding—to work for you.

Tax-loss harvesting in action

Let’s put some numbers behind this to bring it to life. Say you sell Investment A at a loss of $30,000, but you end up with $25,000 in realized gains from Investment B. Your losses would offset your gains, which means that you won’t pay capital gains taxes—and you’ll have $5,000 in losses left over. Under current tax rules, you can use up to $3,000 of that to offset your ordinary income, and you’d be able to use the remaining $2,000 to offset gains in future tax years. Your estimated total tax savings from using tax-loss harvesting would be $4,800, based on a long-term capital gains tax rate of 15% (applied for holding the funds for 1 year or more) and an ordinary income tax rate of 35%.*

Cost basis options

To use tax-loss harvesting, you’ll need to identify specific lots of shares to sell. The specific identification cost basis method is more work but can help you reap the greatest tax benefits if you’re willing to put in the time. You can also elect the MinTax cost basis method to assist in performing tax-loss harvesting. When selling shares, it’s important to consider the holding period. If you own your investment for 1 year or more, you’re subject to a long-term capital gains tax rate, which ends up being 15% for most individuals. If you own the investment for less than a year, you’re subject to a short-term capital gains rate that’s taxed at your ordinary income tax rate, which is often higher than 15%.

The ins and outs of tax-loss harvesting can be tricky to navigate and may require extra effort on your part. If you enjoy managing your assets, learn more about how to minimize your taxes with this strategy.

Wash-sale considerations

As mentioned above, it’s important not to engage in wash sales when performing tax-loss harvesting. While a full discussion of the IRS wash-sale rule is beyond the scope of this article, here are some key considerations to keep in mind.  

In general, the IRS wash-sale rule states that where a sale or other disposition of shares of securities results in a loss, that loss is disallowed if you’ve acquired (including through an issuer’s dividend reinvestment program) substantially identical securities within a 61-day period beginning 30 days before the date of the sale and ending 30 days after the sale. If you acquire substantially identical replacement shares, the loss would be deferred or, in some cases, disallowed entirely.

The IRS wash-sale rule applies not only to purchases of substantially identical securities within the same account, but also to purchases of substantially identical securities acquired in other accounts owned or controlled by you or your spouse or partner, including tax-deferred accounts such as IRAs and 401(k) plans. 

Additionally, accounts owned by your spouse, partner, or other entities you own or control are also subject to the IRS wash-sale rule. At tax-reporting time, you’re obligated to accurately report on your tax return any capital gains and losses realized for the year, taking into account any wash sales that occurred in your overall investment portfolio that year.

Further, current tax laws aren’t always clear around what constitutes a substantially identical security for purposes of the wash-sale rules, particularly in the context of passively managed index funds or ETFs (exchange-traded funds). Since tax-loss harvesting can be complex, we recommend you consult a tax and/or legal advisor about your individual situation before engaging in this strategy. For more information about the risks associated with tax-loss harvesting, see below.**

Be sure to check out the IRS website  for helpful information about tax-loss harvesting. The treatment of capital gains and losses, including the ability to offset gains with losses, is subject to current tax provisions. Please see IRS Publication 550, Investment Income and Expenses, for additional information. Tax-loss harvesting may also affect your state or local taxes.