Tax Loss Harvesting

What is Tax Loss Harvesting?

If an investor has incurred or will incur capital gains, tax loss harvesting may be an option for reducing the tax burden of the gains. Tax loss harvesting is the practice of selling securities at a loss to offset capital gains. Loss harvesting is typically used to offset short-term capital gains, since these generally are taxed at the investor’s ordinary income tax rate rather than the lower long-term capital gains tax rates.

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In addition to offsetting gains with a recognized loss, an investor can use losses that exceed capital gains to offset ordinary income, up to a maximum of $3,000 per year. Losses that exceed the $3,000 threshold can be carried forward into future tax years.

The IRS has ruled that investors who sell securities for a loss must wait 30 days before buying the same or “substantially identical” securities. People who would like to claim the loss but do not want to be out of the market for 30 days can purchase a security that is not “substantially identical” in its makeup but still has a similar investment objective. For example:

  • An investor could intentionally sustain a loss from a mutual fund that invests in large companies and then purchase a large company fund from a different issuer to maintain exposure to the asset class.
  • An investor could intentionally sustain a loss in an actively managed small company fund and replace the position with a small company index fund.

These examples are for illustrative purposes only and are not intended to be a recommendation for any individual investor.

Tax loss harvesting can be an effective tool in reducing year-end taxes. In order to determine whether you should use tax loss harvesting, please consult a tax adviser.