With the end of the year approaching, now is an ideal time to review your portfolio and implement strategies to minimize your tax liability. One powerful tactic to consider is tax-loss harvesting, which helps reduce your taxable income while keeping your investment plan on track for the long term.
What is Tax-Loss Harvesting?
Tax-loss harvesting involves selling investments that have declined in value to generate a realized loss. These losses can offset capital gains from other investments, reducing the taxes you owe. If your losses exceed your gains, you can apply up to $3,000 annually to offset ordinary income, with any remaining losses carried forward to future tax years.
How It Works
Here’s a step-by-step breakdown:
- Identify underperforming investments: Look for securities in your taxable accounts that are worth less than what you paid for them. It’s important to set aside emotions when evaluating these. Here’s how to keep emotions out of investing.
- Sell the investments to realize a loss: Capturing these losses provides a valuable tax benefit.
- Reinvest in similar (but not identical) assets: This maintains your portfolio’s target allocation while avoiding the wash-sale rule.
- Offset gains or income: Realized losses can offset capital gains, and if losses exceed gains, up to $3,000 can reduce ordinary income, with any excess carried forward.
Example in Action
Let’s say you bought $10,000 worth of Stock A, which is now valued at $7,000. By selling it, you realize a $3,000 loss. This loss can offset $3,000 in capital gains from other investments. If you don’t have gains this year, you can apply the loss to reduce your ordinary income or carry it forward to offset future gains.
Benefits of Tax-Loss Harvesting
Tax-loss harvesting offers several advantages:
- Lower Tax Liability: By offsetting gains or reducing ordinary income, you can significantly reduce your tax bill.
- Opportunity to Rebalance: A chance to evaluate your asset allocation.
- Improved After-Tax Returns: Put your tax savings to good work. Invest those savings to boost your portfolio’s long-term growth.
- Carry-Forward Flexibility: Losses exceeding the annual limit can be applied in future years, providing ongoing tax benefits.
Watch Out for the Wash-Sale Rule
To fully benefit from tax-loss harvesting, it’s essential to avoid the wash-sale rule, which disallows a tax deduction if you buy the same or a “substantially identical” security within 30 days before or after selling it at a loss. Careful planning ensures compliance while keeping your investment strategy intact.
When to Consider Tax-Loss Harvesting
While this strategy can be beneficial, it isn’t right for everyone. It’s most effective for investors with taxable accounts who have realized gains to offset or who anticipate gains in the near future. Consider these factors:
- Your tax bracket and how reducing taxable income could impact your financial plan.
- Transaction costs, which should not outweigh the potential tax savings.
- Long-term investment strategy, ensuring tax-loss harvesting aligns with your overall financial goals.
If you’re curious about how tax-loss harvesting could fit into your financial plan, we’re here to help. Contact us to explore how this strategy—and others—can work together to optimize your portfolio and support your long-term goals.
The commentary on this website reflects the personal opinions, viewpoints, and analyses of the Trinity Wealth Management, LLC employees providing such comments, and should not be regarded as a description of advisory services provided by Trinity Wealth Management, LLC or performance returns of any Trinity Wealth Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data, or any recommendation that any particular security, portfolio of securities, transaction, or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Trinity Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
