Tax-loss harvesting is a strategy that helps investors get the most out of their investments. It can also improve your overall return on portfolio, by using losses from selling low performing stocks to offset any potential gains in other areas like interest or dividends.
Tax-loss harvesting helps investors reduce their taxes owed on capital gains or regular income. It can also improve overall investment returns by replacing an underperforming asset with one of similar quality. Then you use the old loss to offset any realized gain in value when selling it at maturity.
Tax-loss harvesting only applies to taxable investment accounts. Retirement plans such as IRAs and 401(k)s grow tax-deferred so they’re not subject the same capital gains taxes as other types of investments.
What You Need To Know About Tax-Loss Harvesting
You may ask yourself how does a loss from one investment help me with my taxes? A major advantage of investing in stocks and bonds is that you can use any losses to offset other types of income. Married couple filing jointly can claim up to $3K per year in realized losses can be used against ordinary income on federal taxes.
The strategy of tax-loss harvesting allows investors to take advantage not just this year, but also in future years. Capital losses can be used as a form or offsetting income and carried over into next periods too!
Understanding Capital Loss
The beauty of investing is that you can use your losses to offset gains and increase total portfolio value. For example, if an individual invests $10K in a certain ETF at the start of the year but it decreases by 10%, they will still be able take advantage (and get credit) for their decline even though there was no profit whatsoever lost.
Capital losses can be framework to optimize your taxes. You may have heard the term “losses are good” before, but it’s true! A capital loss occurs when an investment decreases in value from where the investor purchased it at. This isn’t recognized however, until you sell an investment for less than what you originally bought it at.
Imagine the opposite happens and the market reversed course with the investment closing out at $10,800. Pre-tax that represents an incredible 10% return (after adding in typical 2%). assuming you are taxed highest rate possible 9%. Which accounts for 8%, plus 1.4% dividends paid back by company.
Imagine the investor who sold their stock at a loss of $1,000 and then purchased additional shares with the proceeds. This move is perfect for those reporting taxable capital gains or taxes on ordinary income because it can help save them money in both areas. In this case we’ll assume that you’re looking to avoid paying any higher rates by offsetting your losses from selling certain investments before they realize profits from these positions. This could otherwise be taxed as such if not used properly through dividends and interest payments.
After using tax-loss harvesting, this investor’s net after-tax return on their investment would be approximately 16.6%. This is equal to 9% plus 7.6%.
The Limitations to Tax-Loss Harvesting
Wash-Sale Rule
Investors cannot deduct a capital loss on the sale of one security against another. This is called “wash sales” and they’re designed to prevent taxpayers from selling or trading at losses, within 30 days before/after this transaction acquiring other stocks in the same security. If you do have two trades that are close enough for tax purposes then your write-off may still get disallowing by IRS. The reason why these rules exist has everything do with ensuring unbiased economic activity where people who’ve done well won’t be tempted into felt pressured tactics just because their investments paid off.
One strategy investors may want to use is replacing individual stocks that they own with mutual funds or ETF’s if those investments are losing value. This way, you can still maintain an asset allocation similar in type and magnitude as before without violating any wash-rules which would result from selling off all your positions at once.
Focusing solely on maximized profit alone might not always produce the best outcome for investors. By having replacement options like this allows the investor greater control over what gets sold while protecting their original investment portfolio.
Tax Liability Threshold
The most significant benefit of realizing capital losses of up to $3,000 can be applied to reduce taxable income in one year. In addition, those married but filing separately can deduct up to $1,500 per year and any additional loss may be carried forward for use on future returns.
Administrative Costs
Harvesting losses when the market goes down can be a mundane and time-consuming task. It’s important to keep in mind that you should only harvest these if they outweigh your tax preparation hassle vs administrative cost of doing so.
Tax-loss harvesting and portfolio rebalancing can work together to create a more profitable investment strategy. Periodic review of your investments will help you identify lagging assets that might be good candidates for tax saving, as well.
Final Thoughts
Tax savings should never lessen or stand in the way of your investing goals. In some cases, after-tax returns can be boosted by this strategy resulting in quicker asset accumulation. Taxation creates an opportunity for tax loss harvesting as an investment technique.
Investing isn’t a one-size fits all game. You should take an balanced approach and reevaluate your portfolio routinely. This will ensure that everything is in line with what’s best for achieving the goals of investing.
There are many benefits to taking a strategic approach when it comes time for retirement investing. Paragon Private Wealth Group™ offers goal-driven plans that will help you maximize your income while minimizing taxes, and they provide personal service at low costs! Start the conversation today by learning about how their experts can develop an investment strategy just for you—discover all of these great features now on our website.
