Tax Loss Harvesting 

An often-overlooked strategy is tax loss harvesting, and I can understand why someone would use this strategy. I always believe that the glass is half full and that turning something negative into a positive is what tax loss harvesting is. This strategy is used in brokerage accounts and not retirement accounts because, in retirement accounts, the taxes are deferred or tax-exempt by the IRS code.  

Tax-loss harvesting is a strategy used to reduce your tax liability by selling investments that have lost value to offset the gains from other investments. Here’s how it works:

How Tax-Loss Harvesting Works

Identify Losses: Review your portfolio to identify investments currently worth less than what you paid for them.

Sell at a Loss: Sell these underperforming investments to realize a capital loss.

Offset Gains: Use the capital losses to offset any capital gains you have realized from selling profitable investments. This can reduce your overall taxable income.

Reinvest: To maintain your investment strategy, you can reinvest the proceeds from the sale into similar, but not identical, investments. This helps you avoid the IRS wash-sale rule, which disallows the tax deduction if you buy the same or a substantially identical investment within 30 days before or after the sale.

Benefits of Tax-Loss Harvesting

Reduce Taxable Income: You can lower your taxable income by offsetting gains with losses.

Carry Forward Losses: If your losses exceed your gains, you can use up to $3,000 of the excess loss to offset other income. Any remaining losses can be carried forward to future tax years.

Example

Imagine you bought a stock for $10,000, but it’s now worth $7,000. Selling it would result in a $3,000 loss. If you also sold another stock for a $3,000 gain, the loss would offset the gain, resulting in no capital gains tax for that year.

Tax-loss harvesting can be a valuable tool for managing your investment portfolio and reducing your tax burden. However, it’s important to consider transaction costs and their impact on your overall investment strategy. Consulting with a financial advisor can help you navigate this process effectively.

The wash-sale rule is an IRS regulation designed to prevent investors from claiming a tax deduction for a security sold in a wash sale. Here’s a breakdown of how it works:

Key Points of the Wash-Sale Rule

Definition: A wash sale occurs when you sell a security at a loss and then repurchase the same or a “substantially identical” security within 30 days before or after the sale.

Disallowed Loss: If a wash sale occurs, the loss from the sale cannot be deducted for tax purposes.

Substantially Identical: This term includes the same stock and options or contracts to acquire the same stock.

Replacement Period: The rule applies to purchases made within a 61-day window, which includes 30 days before and 30 days after the sale.

Example

If you sell 100 shares of XYZ stock at a loss on January 1st and then buy 100 shares of XYZ stock on January 15th, the loss from the January 1st sale is disallowed for tax purposes because it falls within the 30-day window.

Avoiding the Wash-Sale Rule

To avoid triggering the wash-sale rule, you can:

Wait 31 Days: Before repurchasing the same or substantially identical security.

Buy Similar but Not Identical Securities: For example, if you sell shares of one tech company, you could buy shares of another tech company instead.

Reporting

Wash sales must be reported on IRS Form 8949, details the transactions and adjustments for all capital gain and loss transactions.

Understanding and adhering to the wash-sale rule can help you manage your investments more effectively and avoid unexpected tax issues. If you have specific scenarios or further questions, feel free to call us!

Chris graduated from the University of Maine, where he played hockey on a scholarship, and retired from professional hockey in 2007. In the community, he remains engaged, serving as a youth hockey coach. Chris holds the CERTIFIED FINANCIAL PLANNER™. Outside the office, he enjoys trying new food and wine, reading, traveling, playing golf and hockey, fat tire biking, and donating to local charities. His passions include being a husband and dad, lake life with the family, watching his son and daughter play sports, and spending time with his wife. To learn more about Chris, connect with him on LinkedIn.