Tax loss harvesting is a financial planning habit most investors fail to take advantage of, so let’s explore the concept in a little more detail.
With the end of the year nearing, you may be able to take your poor stock picks and recover some of your money by realizing a few tax breaks. Harvesting your losses on your income taxes is an effective way to put more money in your pocket come April.
Few investors understand just how powerful it can be.
Even if you want to keep a stock that has performed poorly, it can still be well worth the risk to sell it and repurchase it in a month.
Tax loss harvesting has three primary tax benefits:
By offsetting your gains, you’re in essence receiving a tax-free loan that you can use to invest in other securities. Until you realize any gains from that next round of investments, you’re deferring your capital gains taxes.
For many investors, the tax on personal income is higher than the tax on capital gains. If your losses are greater than your gains, you can apply the remaining loss to your personal income.
Suppose your losses were $5,000 greater than your gains. You could write off $3,000 from your income this year and $2,000 the following year.
Consider how powerful this can be. The ability to deduct losses from your income is a huge advantage.
The IRS doesn’t like it when you sell a security for the purpose of receiving a tax break. Hence, there is a law. You cannot repurchase a stock within 30 days if you chose to write off your loss. You also have to wait 31 days after purchasing a security to sell if you want to write off the loss.
In today’s world, transaction costs are normally very small. But consider the costs when deciding if harvesting your losses is worth it. If you’re selling a small amount of stock, or the loss is small, it might not make financial sense.
Just because your investments are down, doesn’t mean that this exact moment is the best moment to sell. You might be better served by waiting. Consider what the future may hold.
Consider this example of loss-harvesting in action:
Suppose that you had owned a stock for more than 30 days, and the price had fallen by 50% since you purchased it. You like the stock and would like to keep it. You also don’t expect anything exciting to happen in the next 30 days.
You decide to sell the stock for a $7,000 loss. You also have capital gains of $1,000. You can avoid paying taxes on your capital gains, and write $3,000 off your income. You can then rollover $3,000 of loss to the following year. After 31 days, you can repurchase the stock.
You’ve reestablished your position and saved a lot money in the process.
Is tax loss harvesting something you can benefit from? Have you been taking advantage of your underperforming stocks to the best of your ability?
Harvesting your losses intelligently can pay big dividends at tax time. Ensure that you’re taking full advantage of the tax laws.
An Intrinsic Coach® and enthusiastic student of personal development, I've been actively writing on a range of related topics for over 10 years. The range of topics I share has varied over time, but I try to pick ones that will hopefully strike a chord with you. You may or may not always enjoy everything I write, but if you appreciate the effort please make a point to share it with someone else.