Offsetting gains through tax-loss harvesting
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."*
Capital gains that are now taxable because the investment has been sold at a higher purchase price than what was originally paid.
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, but the tax burden is deferred if you hold the investment in an IRA or a 401(k).
Rebalancing involves periodically buying and selling the stocks, bonds, cash, or other investments in your portfolio to maintain your original or desired mix of those assets.
An investment that represents part ownership in a corporation. Each share of stock is a proportional stake in the corporation's assets and profits.
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.
Income you can receive by investing in bonds or cash investments. The investment's interest rate is specified when it's issued.
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.
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.
Find out more about the "specific identification" cost basis method
Shares acquired in one transaction. You can own multiple lots of an investment if you acquired shares of the same security at different times.
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.
*Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. We recommend that you carefully review the terms of the consent and consult a tax advisor before taking action.
**Information about shares purchased before certain dates won't be reported. Learn more about covered & noncovered shares
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