Article in Summary:
- By selling for a loss, you can offset future gains, up to $3,000 worth of ordinary income each year.
- This procedure is called Tax Loss Harvesting
The other day a prospect came to my office who was looking for someone to help him manage his nest egg as he prepared for retirement. He was expecting a windfall after he sold his business of around 1 million dollars. Couple that with his current nest egg of $1.5 million, he was looking forward to a nice income in retirement. But one thing puzzled me: he had $200,000 in 2008 losses in his brokerage account that he hadn’t captured for tax purposes.
I asked him why he hadn’t taken advantage of his losses for tax purposes. He just shrugged. Then I explained that by selling for a loss, he could use these losses to offset future gains, and up to $3,000 worth of ordinary income each year. If he was worried about missing a market recovery, he could invest in a similar investment and remain exposed to any upturn in the market market. He shrugged again.
A couple of weeks later, I called him to see if he had considered what I shared with him. The truth came out. He said that right now, they are only paper losses. If he sold, they’d be actual losses, and it hurt too much to acknowledge that he’d lost $200,000 in the market. If they can make it back to even, he wouldn’t have lost anything. While psychologically comforting, he would have lower taxes if he captured his losses.
This procedure is called Tax Loss Harvesting. It is when you sell your investments that are below your original investment to capture losses for tax purposes. By selling your losing positions, you recognize losses that you can use in several ways for tax purposes. Let’s explore a few:
- Against Current Capital Gains –Any investment gains you have can be offset by captured losses.
- Against Future Capital Gains – Losses in excess of current gains can be carried forward and used against future gains which will probably be at higher capital gain tax rates.
- Against up to $3,000 of Ordinary Income – You can offset up to $3,000 of ordinary income with losses you’ve captured. (For example – If you pay 30% in taxes, you’ve just lowered your taxes by $900 each year until you use your losses up. (30% x $3,000 = $900).
- Against Small Business Property Capital Gains – Depending on how your business is structured, you might be able to offset gains from the sale of business property on Form 4797. Under Part I, line 9 you enter the gain from line 9 as a long term capital gain on the Schedule D filed with your return.