What Is Tax-Loss Harvesting?

Investing comes with risk. A lot of it.

Of course, if you’re a seasoned investor, we’re surely not telling you anything new. After all, phrases like “all investments carry risk” are littered across online stockbroker websites, investing blogs, and financial product brochures.

When you put money into an investment, you’re speculating. You’re weighing the potential risk against the potential reward of that particular investment and making an educated guess. Your financial situation and investing experience can help you determine whether you should take on the risk, but you never truly know—even famously reliable investments have had their down years.

Nobody wants to lose money—well, that we know of—but it happens all the time.

Okay, we’re done being downers. It’s just not our style. We prefer to spend our time thinking about solving problems, not just dwelling on the problems themselves.

Yes, you can always lose money on investments. But did you know that if you play your cards right and think about your investments strategically, you can end up with big tax savings come tax time?

You can. Let us introduce you to our friend: Tax-loss harvesting.

Today, we’re going to walk you through the tax-loss harvesting basics, from what it is and its major benefits to how you can employ it in your tax return—and beyond!

Tax-Loss Harvesting: A Beginner’s Guide

Tax-loss harvesting is a pretty straightforward tax strategy that can help you weather market volatility, so we’re going to start you out with a basic description of how it works.

Investors who employ tax-loss harvesting will intentionally generate losses in taxable accounts by selling off investments that have lost value.

Let’s break this down a bit. When you purchase an investment product like a stock or even a rental home, that asset is considered as having the value of your purchasing price—until you sell. At that point, the value has typically either gone up or gone down.

If the value has gone up, congratulations! You made money. However, that money is considered a “capital gain” and is taxable. On the contrary, if the value has dropped, Uncle Sam empathizes. You can apply your losses to offset your gains, or if the losses offset the gains, you can offset up to $3,000 of ordinary income!

Benefits of Tax-Loss Harvesting

Taxpayers employ tax-loss harvesting for a range of specific reasons, but they all boil down to one major purpose: deferring your tax burden.

Probably the most crucial element you need to remember about tax-loss harvesting is that you aren’t completely ridding yourself of your tax debt. Instead, you’re strategically cutting your losses to maximize your tax benefit in a given year. By cashing out the investments you’ve earned losses in, you can write off those losses against your income for the year.

The Tax-Loss Harvesting Process

The process is pretty simple, but you should still make your decisions based on your own research and consultation with a financial advisor.

First, you need to identify your primary investment losses. Some of these investments you may not actually wish to get rid of; after all, some losses may simply be dips or part of a long-term strategy. However, the ones you can consider losses and don’t mind removing from your portfolio—go for it.

From here, you can apply your losses to any gains you’ve realized. If you haven’t sold any investments that have realized gains, then your losses will be reported against your income—by up to $3,000. We’ve written on this step of the process before, so feel free to check it out.

Tax-Loss Harvesting Isn’t For Everyone

When it comes to taxes, we’re happy to join your team and help guide you. But when it comes to your investments, it’s always good to have a financial advisor in your corner.

The truth is, tax-loss harvesting—like just about any tax strategy—isn’t for everyone. Whether you can use a specific deduction and whether you should use a specific deduction are two different questions. What’s equally important is that you make wise financial decisions when it comes to investments, so never skip that step in order to employ tax-loss harvesting.

Turning Your Losses into Gains

Not every loss has to stay one. By employing the right tax strategies, you can turn your losses into gains and reduce your tax burden. While this doesn’t get rid of your tax obligation permanently, it can really help reduce the money you leave on the table over time.

And more money in your pocket is pretty much always a good thing—right?

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