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Tax-loss harvesting is a strategic financial practice involving the sale of securities at a loss to offset capital gains, providing a valuable tool for managing tax liability. While it doesn’t eliminate losses, this approach can help optimize your overall tax position. Here’s a closer look at how tax-loss harvesting works, potential pitfalls, and its year-round applicability.
How It Works:
- Deductible Capital Losses:
- Federal tax returns allow a deduction of up to $3,000 of capital losses exceeding capital gains each year. (You can write off $3,000 of losses against your income if your losses exceed your capital gains)
- Excess losses beyond $3,000 can be carried forward, potentially offsetting future capital gains.
- Offsetting Current-Year Gains:
- A key strategy in tax-loss harvesting involves using the entire harvested loss to offset any capital gains in the same tax year.
- By zeroing out gains through this approach, you may effectively reduce your taxable income for the year.
- Carrying Forward Excess Losses:
- Any remaining losses beyond the annual $3,000 deduction limit can be carried forward to subsequent tax years.
- These carried-forward losses maintain their potential to offset capital gains in future years, providing a valuable tool for long-term tax management.
- Deductible Capital Losses:
- Wash-Sale Considerations:
- The IRS enforces the wash-sale rule, preventing the claiming of a loss on a security if a similar security is bought within 30 days before or after the sale.
- It’s crucial to avoid buying a “substantially identical” security during this period to adhere to IRS guidelines.
- Portfolio Considerations:
- Selling assets for tax-loss harvesting may impact a long-term portfolio strategy, necessitating a thoughtful approach.
- Tax-loss harvesting is applicable only to taxable accounts; tax-advantaged accounts are ineligible for this strategy.
- Ongoing Opportunity:
- While some investors focus on tax-loss harvesting as the year concludes, it’s a strategy worth considering throughout the year.
- Continuous evaluation of your portfolio allows for timely identification of opportunities to harvest losses.
It’s essential to note that tax-loss harvesting requires careful consideration of individual circumstances and adherence to IRS regulations. Seeking guidance from tax or accounting professionals is crucial before implementing any tax strategy involving tax-loss harvesting. This proactive approach can help enhance tax efficiency and contribute to a well-rounded financial strategy.
Remember, this information is for informational purposes only and should not replace personalized advice from professionals.