How Tax Loss Harvesting Works

Just as farmers work to bring in the bounty of the harvest every Fall, come 4th quarter investors can work to bring in a bounty of their own.  In the later case, they’re harvesting something much less appetizing than produce, though certainly no less valuable – tax losses!

When the financial markets are volatile like they’ve been the past couple of years, investments purchased at different times end up with very different unrealized tax situations.  This means you may have the opportunity to “harvest” or sell some of your investments and bank the tax losses to use on your tax return.

Remember, tax loss harvesting only works in after-tax accounts.  Just as profits in your IRAs and 401ks aren’t taxed, tax losses in your retirement accounts are not tax deductible.

So, why harvest tax losses in taxable accounts?  First, your harvested tax losses can offset any capital gains you incur dollar for dollar.  Second, you are allowed to use $3,000 of tax losses on your tax return to reduce your taxable income each year.  In addition, any losses in excess of $3,000 can be carried forward as long as you live to reduce tax bills in future years.

To ensure that you’re continually invested in the market after you harvest your tax losses, you’ll want to immediately reinvest your sale proceeds.  Since the IRS “wash sales” rule states that you cannot buy back the same holding right away, you want to instead reinvest the sale proceeds into a similar investment.

Tax loss harvesting is an important tax savings tool when it comes time to rebalance your portfolio or sell real estate or other capital assets at a gain.  It can even help protect against future increases in the federal income tax rates.

So, take a page from the Farmer’s Almanac come Fall and bring in a profitable harvest of your own.  Remember, to benefit from the harvested losses on your annual tax return, you must sell the holdings and realize the loss by December 31st!

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Woodward Advisors

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