How to Use Tax Loss Harvesting to Reduce Your Tax Burden

As the year comes to a close and we’re reviewing our investments, it's a great time to think about minimizing our tax burden. One powerful, often overlooked strategy is tax loss harvesting. This technique can significantly reduce your capital gains taxes, and it's much simpler than you might think.

What is Tax Loss Harvesting?

Simply put, tax loss harvesting involves selling investments that have lost value (at a loss) to offset capital gains you’ve realized during the same tax year. When you sell an investment for less than you bought it for, you generate a capital loss. You can then use this loss to cancel out any capital gains you’ve made throughout the year.

How Does It Work?

Let's say you’ve made a profit of $5,000 from selling stocks. However, you also sold a stock for a loss of$ 2,000. You only pay taxes on the $5,000 in gains. By strategically selling the losing stock, you can use the$ 2,000 loss to offset that $5,000 gain, reducing your taxable capital gains income to$ 3,000.

Key Rules and Considerations:

Wash Sale Rule: This is crucial. The IRS has a rule called the “wash sale” that prevents you from claiming the loss if you repurchase the same or substantially identical security within 30 days before or after the sale. This prevents you from artificially inflating your tax deduction. The 30-day window applies regardless of whether the repurchase is a purchase of the exact same stock or a similar one.
Non-Taxable Gains: Losses can only offset gains. If you have losses exceeding your gains, you can carry those losses forward to future tax years. You can carry forward unused capital losses indefinitely, which is a significant benefit.
Mutual Funds & ETFs: Tax loss harvesting is particularly effective with mutual funds and ETFs. You can sell shares within the fund to realize losses without selling the underlying securities.
Brokerage Accounts: Most major brokerage firms now offer tools and services to assist with tax loss harvesting. Look for features that automatically identify potential opportunities.
Tax Planning: It's a good idea to consult with a financial advisor or tax professional to ensure you’re implementing tax loss harvesting strategically and legally.

Example Scenario:

Let’s say you have the following:

Capital Gain from Stock A: $3,000
Capital Loss from Stock B: $4,000

You can use the entire $4,000 loss to offset the$ 3,000 gain.

Resources for Further Learning:

Investopedia - Tax Loss Harvesting: https://www.investopedia.com/terms/t/tax-loss-harvesting.asp
IRS - Wash Sale Rule: https://www.irs.gov/newsirs/wash-sale-rule

Disclaimer: This information is for educational purposes only. Consult with a qualified financial advisor before making any investment decisions.*