How Tax-Loss Harvesting May Help Lower Your Tax Bill
A volatile year in the financial markets can create opportunities for reducing your taxable income.
Many investors use the closing months of the year to review their portfolios and assess their winning and losing investments. It’s also a good time to do tax planning for the upcoming filing season; decisions you make before year-end can help you lower the taxes you own on your ordinary and investment income.
Tax-loss harvesting is one strategy many investors use to offset taxable investment income and capital gains with capital losses. After a volatile year in the markets, you may see a stark divide between winners and losers in your portfolio. There is opportunity, however, to consider selling certain investments that realize losses you can use to lower your overall tax bill.
You can also use tax-loss harvesting to reduce your ordinary taxable income, if you realize losses in excess of your total capital gains for the year. You can apply capital losses up to $3,000 in a calendar year—a small amount, but potentially significant if the credit lowers your total annual taxable income and keeps you from moving into a higher tax bracket.
Know the “wash sale” rule. If you plan to sell a security for a loss, the IRS forbids the purchase of the same security or a “substantially similar” security for 30 days before and after the sale. This type of transaction is known as a “wash sale”. It’s an important rule to remember if, for example, you want to sell an indexed ETF and purchase another ETF linked to the same index. Violating the wash-sale rule could disallow any offset losses, not only for the current tax year but potentially future tax years as well.
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Gregory Armstrong, CFP®