Tax Loss Harvesting 101

Sometimes, even a bad investment can be a good thing. That’s because there’s a practice called tax-loss harvesting.  

Tax loss harvesting is selling off poorly performing stocks at a loss to offset capital gains made from better-performing stocks. Tax-loss harvesting might be a boon for your tax picture now and down the road. The process can get a little tricky, but that’s why we’re here to explain it.  

What to Know About Tax-loss Harvesting

Tax-loss harvesting is a process through which you can sell down poorly performing investments. This loss can be used to reduce taxable capital gains and offset up to $3,000 of your income. After selling, you take that money and reinvest it into additional security.  

Less money goes to taxes, and more goes to work for you. For example, if you have some poorly performing stocks, tax loss harvesting allows you to sell off those stocks at a loss. You then offset some of your taxable gains on other stocks. 

When it comes to tax-loss harvesting, we suggest working with someone experienced in this area of tax law. The waters can get murky, and you don’t want to trigger an audit. For instance, stocks that have performed well can mean a higher tax bill for you in terms of the capital gains you’ll be required to pay.  

Taxing Short-term and Long-term Capital Gains

Short-term capital gains are financial gains on investments you’ve owned for one year or less. Long-term capital gains are financial gains on assets held for longer than one year. Short-term capital gains are taxed at the marginal tax rate as your ordinary income and based on your filing status. For 2021, a typical tax rate ranges from 10% to 37%. 

For profits from long-term capital gains, you often have a reduced tax rate. This reduced rate will depend on your tax bracket. If you’re in a high-income bracket, you can save up to 17% off your ordinary income rate. If you’re in a lower-income bracket, your tax rate could be as low as 0%. 

What About Mutual Funds?

Pay attention to projected distributions from mutual funds because they can cost you capital gains if they yield high. However, if there’s a loss in the value of a mutual fund, harvested losses can offset these gains at tax time. This is because short-term capital gains from mutual funds are taxed as ordinary income. 

Avoid the Wash Sale

The wash-sale rule says that your tax write-off won’t work if you buy the same security, contract, option, or a “substantially identical” security within 30 days before or after you sell one off. So instead, when you sell off stock for tax reasons, consider substituting a mutual fund or an exchange-traded fund (ETF) within the same industry. 

How to Maximize Your Savings

Consider the role tax harvesting could play in your year-round investing plan. A professional portfolio manager can tell you if tax harvesting could help save you money.  

Since practices such as tax loss harvesting are not just done at tax time, consider having an ongoing business relationship with a tax attorney. They can help you determine the right fiscal approach during a volatile market. 

The experienced attorneys at Hackstaff Snow Atkinson & Griess can help get you the information you need to make intelligent investments that won’t hurt you down the road. In addition, our experienced attorneys can assist you in creating a cost-effective harvesting strategy. To schedule a consultation, reach out to our legal team today.