Tax-loss harvesting is an investment strategy that aims to reduce the tax burden of the year by selling losing securities to offset capital gains taxes. It not only helps investors reduce taxes, but also optimizes taxes while maintaining portfolio allocation. This article will introduce the basic concepts, operation procedures, advantages and risks of tax-loss harvesting, as well as relevant tax rules, to help you use this strategy reasonably.
1. What is tax-loss harvesting?
Tax-loss harvesting refers to investors selling losing securities in taxable accounts, recognizing capital losses, and offsetting capital gains from other investments. If the loss exceeds the capital gain of the year, it can also be deducted from ordinary income up to $3,000, and the remaining loss can be carried forward to future years for continued deduction.
2. How does tax-loss harvesting work?
- Identify loss assets
Investors regularly check their portfolios to find securities whose current market value is lower than the purchase cost. - Selling loss-making securities
Realizing capital losses by selling loss-making securities generates a “tax loss” that can be used to offset taxes. - Offsetting capital gains
Using losses to offset capital gains in the same year reduces taxable income. - Offsetting ordinary income
If the amount of losses exceeds capital gains, up to $3,000 of ordinary income can be deducted. - Carry forward unused losses
The excess losses can be carried forward to future tax years for continued tax deduction. - Reinvest in similar assets
In order to maintain portfolio allocation, investors usually purchase securities that are similar but not identical in nature to avoid the restrictions of the “wash sale rule”.
3. Advantages of tax loss harvesting
- Reduce tax burden
Reduce tax expenditures for the current year by offsetting capital gains and part of ordinary income. - Improve portfolio efficiency
Achieve tax optimization without changing long-term investment strategies. - Enhance cash flow
The tax savings can be reinvested, and the compounding effect can be used to increase wealth growth. - Flexible response to market fluctuations
Take advantage of market declines to lock in losses and optimize tax results.
4. Key tax rules and restrictions
- Wash-Sale Rule
The IRS stipulates that if “substantially identical” securities are purchased within 30 days before or after the sale of loss-making securities, the losses cannot be used to offset taxes and must be deferred until the new securities are sold. - Matching short-term and long-term capital gains
Losses should be offset against capital gains of the same nature first (short-term losses offset short-term gains, long-term losses offset long-term gains), and the excess can be offset against other categories. - Loss deduction limit
Up to $3,000 of ordinary income can be deducted each year, and the remaining losses can be carried forward.
5. Potential risks and precautions of tax loss harvesting
- Transaction costs
Frequent buying and selling may incur fees, and tax savings and transaction costs need to be weighed. - Investment risks
Changing investment targets may bring different risks and affect portfolio performance. - Tax complexity
It is necessary to accurately record transactions to avoid violating wash sale rules. It is recommended to seek assistance from professional tax advisors. - Tax deferral is not exemption
Tax loss harvesting mainly achieves tax deferral, and taxes will still need to be paid when new securities are sold in the future.
6. Applicable objects and implementation timing
- Suitable for investors with taxable investment accounts
Tax loss harvesting does not apply to tax-deferred accounts (such as 401(k), IRA, etc.). - High-tax investors benefit more
Those with higher marginal tax rates save more taxes through this strategy. - Market volatility timing
Tax loss harvesting works best when the market adjusts or falls. - Year-end or periodic assessment
Most investors adopt this method when planning their taxes at the end of the year, and they can also do it regularly according to market conditions.
Tax loss harvesting is an effective tax strategy that helps investors reduce their tax burden and optimize their investment portfolios by making reasonable use of investment losses. Understanding its operating mechanism and relevant tax rules, and planning trading timing reasonably can maximize the benefits of this strategy. Given the complexity of the operation, it is recommended to combine professional financial and tax advice to develop a personalized plan to achieve steady growth of wealth.