Tax Harvesting: How To Lower Your Taxes Before the Year Ends

hamzaturkkol / Getty Images/iStockphoto

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

The end of the year is a great time to consider implementing strategies that can help minimize your tax liability. One effective method is tax-loss harvesting, a tactic that allows you to offset gains with losses, thereby reducing your overall tax burden.

Here’s a quick look at the basics of tax-loss harvesting and how you can leverage it to lower your taxes before the year ends.

Understanding Tax-Loss Harvesting

Tax-loss harvesting involves selling investments that have decreased in value to offset capital gains from other investments. By realizing these losses, you can reduce the amount of taxable income, effectively lowering your tax bill.

It’s a strategy primarily used in taxable accounts, as tax-advantaged accounts like IRAs and 401(k)s don’t benefit from this approach.

Use Tax-Loss Harvesting To Your Advantage

1. Identify Underperforming Investments: Review your portfolio to identify investments that have lost value since you purchased them. These losses can be used to offset gains from other investments that you’ve sold at a profit.
2. Sell to Realize Losses: Once you’ve identified the underperforming assets, sell them to realize the losses. These losses can then be used to offset any capital gains you’ve realized during the year.
3. Offset Gains and Ordinary Income: If your losses exceed your gains, you can use up to $3,000 of excess loss to offset other income. Any remaining losses can be carried forward to future years, providing a tax benefit down the line.

Benefits of Tax-Loss Harvesting

• Reduced Tax Liability: By offsetting capital gains with losses, you can significantly lower your taxable income.
• Portfolio Rebalancing: Selling off underperforming investments provides an opportunity to rebalance your portfolio, potentially aligning it more closely with your financial goals.
• Deferred Tax Benefits: Carrying forward losses to future years can provide ongoing tax relief, reducing your tax bill in subsequent years as well.

Key Considerations

• Wash-Sale Rule: The IRS wash-sale rule prohibits you from repurchasing the same or a substantially identical investment within 30 days before or after the sale that realized the loss. Violating this rule negates the tax benefit of the loss. Plan your trades carefully to avoid triggering the wash-sale rule.
• Long-Term vs. Short-Term Gains: Short-term capital gains are taxed at a higher rate than long-term gains. Prioritize offsetting short-term gains with your losses to maximize tax savings.
• Professional Guidance: Tax-loss harvesting can be complex, especially for large portfolios or those with significant investments. Consulting with a tax advisor or financial planner can help you navigate the intricacies and ensure you’re maximizing your benefits.

Steps To Implement Tax-Loss Harvesting

1. Review Your Portfolio: Regularly check your investments to identify potential losses. Year-end is a common time to do this, but periodic reviews can also be beneficial.
2. Consult a Professional: Discuss your tax situation with a financial advisor or tax professional to tailor the strategy to your specific circumstances.
3. Plan Your Trades: Execute the necessary trades while being mindful of the wash-sale rule. Keep detailed records of your transactions for tax reporting purposes.
4. Reinvest Wisely: After selling off the underperforming investments, reinvest in assets that align with your long-term financial goals. Consider diversification to manage risk effectively.

Tax-loss harvesting is a powerful tool for lowering your tax liability and enhancing your overall investment strategy. By strategically selling underperforming investments to offset gains, you can reduce your taxable income and potentially achieve greater financial flexibility.

Editor's note: This article was produced via automated technology and then fine-tuned and verified for accuracy by a member of GOBankingRates' editorial team.

Share This Article: