Do you know what is tax-loss harvesting? To reduce taxable capital gains, some investors use a tactic known as ‘tax loss harvesting.’ In this manner, investors sell assets at a loss.
Whether long-term or short-term, capital gains are usually taxed at different rates. Hence, this strategy is often used to reduce the latter.
If they do this, investors may keep more of their hard-earned money and pay less in taxes. You can increase your after-tax earnings with this tax-efficient method without having to rethink your investing approach completely.
What is the Process of Tax-Loss Harvesting?
The idea behind capital loss harvesting is that capital losses may immediately offset capital gains. An investor may lower their taxable profits from successful asset sales in the same year by using the losses from underperforming assets sold at a loss.
To implement this, an investor may rebalance their portfolio by selling a losing stock and using the proceeds to buy a comparable (but not identical) investment.
While doing so, substantial tax savings may be achieved without jeopardizing the long-term investment plan.
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Substantially Identical Security and Its Effect on Tax-Loss Harvesting
According to the ‘wash sale rule,’ which the IRS enforces, an investor cannot deduct a loss on the sale of one security if they buy a nearly similar asset either a month before or after the sale.
If you break this guideline, you cannot claim that loss as a tax deduction. Shares in the same firm, shares in the same mutual fund, or specific derivative contracts linked to the same underlying asset are often considered ‘substantially identical’ securities. To stay out of this restriction’s clutches, meticulous preparation is required.
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What is the Annual Amount That I Can Use for Tax Loss Harvesting?
You can claim a deduction of up to $3,000 ($1,500 for married filers) or the net loss shown on Schedule D (Form 1040) if your capital losses exceed your capital profits.
Any losses that exceed that threshold may be used to offset capital gains in subsequent tax years. Thanks to this carryover provision, investors may still take advantage of tax loss harvesting even if their losses are far larger than the yearly deduction limitations.
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The Bottom Line
To reduce taxable income and keep investment portfolios on track for the long run, knowing what is tax-loss harvesting is a valid tax technique. The wash sale rule and yearly deduction restrictions are vital pieces of information that investors need to know to make the most of this strategy. L&Y Tax Advisor can provide you with specialized guidance and help you achieve your goals!
