Tax loss harvesting is a tax strategy that allows investors to minimize their tax liability by selling investments that have decreased in value and recognizing the losses for tax purposes. This strategy can be used to offset taxable gains from other investments and reduce the overall tax bill.
Example 1: Consider an investor who has a stock portfolio valued at $100,000, with a $10,000 loss from a stock that has decreased in value. The investor can sell the losing stock and use the loss to offset gains from other investments in the portfolio, such as stocks that have appreciated in value. If the investor has $10,000 in taxable gains, the tax loss harvesting will offset these gains and reduce the taxable amount to $0.
Example 2: Consider an investor who has a stock portfolio valued at $200,000, with a $20,000 loss from a stock that has decreased in value. The investor can sell the losing stock and use the loss to offset gains from other investments in the portfolio, but only up to $3,000 per year. If the investor has $40,000 in taxable gains, the first $3,000 will be offset by the tax loss harvesting, and the remaining $37,000 will be taxed at the investor's marginal tax rate.
In both examples, tax loss harvesting is a way to reduce the investor's tax bill and increase after-tax returns. It is important to note that tax loss harvesting should only be performed in a well-diversified investment portfolio and should not be the sole factor driving investment decisions. It is also important to consider the wash-sale rule, which disallows investors from immediately repurchasing a security that was sold for a tax loss.
In summary, tax loss harvesting is a tax strategy that allows investors to minimize their tax liability by selling investments that have decreased in value and recognizing the losses for tax purposes. By doing so, they can offset taxable gains and reduce their overall tax bill. It is important to consider the wash-sale rule and ensure that the strategy is used within a well-diversified investment portfolio.
