Tax loss harvesting is a technique used to improve the after tax return of your taxable investments. It’s an opportunity
to get rid of investments that aren’t performing, especially if they are selling for less than you paid for them. Selling them may seem like declaring failure but saving on your taxes will offset the feeling.
Here’s how it works:
1) Sell a security at a loss and buy a similar security. Be aware that if you buy an identical security 30 days before or after the sale, the IRS will disallow it. The “Washday Rule,” as it’s called, is there to prevent investors from making trades to simply avoid taxes. You can buy a similar stock but not exactly the same one.
According to Tom Herman of the Wall Street Journal, you can use your capital
losses to soak up capital gains on a dollar for dollar basis.
2) If your losses exceed your gains or you have no gains at all, you can deduct as much as $3,000 ($1500 if you are married and file separately) from your salary and other ordinary income.
3) It doesn’t count if it’s only on paper, you actually have to sell the stock or security in order for it to count as a “loss.”
The practice of tax loss harvesting will save money because short term capital gains are taxed at a higher rate. Tax loss harvesting can net you up to 1 ½ percent when practiced regularly. While it doesn’t seem like much it can add up.
In order for this to be a viable strategy, only taxable securities can be used, not 401(k) or other tax sheltered plans. The cost of selling them off must also be considered. If the practice is used too often, you may lose what you hoped to have gained to transaction and trading fees. It’s best to implement the practice on a quarterly or yearly basis.
While there are benefits to tax loss harvesting it does give the investor pause. Should he upset the balance of his carefully constructed portfolio for short-term gain? How do you know if it’s worth converting an unrealized loss into an actual loss? Tax loss harvesting may be a good way to keep a stock that’s headed south from becoming a total loss, but consistent healthy returns are still the primary concern for any investor.
Since tax loss harvesting isn’t a widely used strategy you may want to speak up and discuss it with your financial planner.
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