If you’ve ever sold an investment at a loss, it probably stung a little. No one enjoys seeing their portfolio take a hit. But there is a silver lining to it. Those losses don’t have to be completely wasted. In fact, with the right strategy, they can help lower your tax bill and free up more money to invest.
That is the idea behind tax-loss harvesting, a technique that smart investors use to make the most out of their losing investments. Whether you’re an experienced investor or just getting started with it, understanding how it works can give you a valuable edge.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is the practice of selling investments that have dropped in value so you can use those losses to offset your taxable gains. Think of it like recycling, but financially. You’re taking something that didn’t go as planned and turning it into something useful.
The basic process of tax-loss harvesting goes like so:
You sell an investment at a loss. You use that loss to reduce your taxable capital gains from other investments. And if your losses exceed your gains, you can use up to $3000 of the remaining amount to reduce your regular taxable income.
If you still have leftover losses, you can carry them forward into future years.
Why Investors Use It
The obvious reason is to pay less in taxes, but that’s not the only benefit. Tax-loss harvesting can also help with rebalancing your portfolio. Selling underperforming assets frees up cash to reinvest in areas that fit your current strategy.
Also, by reducing your tax, you’re keeping more of your gains compounding year after year. And even when the market is down, there’s still a way to make it work for you.
Watch Out for the Wash Sale Rule
The IRS has a big “but” when it comes to tax-loss harvesting. The wash sale rule says that you can’t claim a loss if you buy the same or identical investment within 30 days before or after selling it.
That means, if you sell a losing stock to harvest the loss, you shouldn’t immediately repurchase it – or something nearly identical – or you’ll lose the tax benefit.
Timing Matters
A lot of investors wait until the end of the year to review their portfolios for tax-loss harvesting opportunities, but you don’t have to. If you have significant gains earlier in the year, you can also look for losses to offset them before December.
The key is to balance the tax advantage with your long-term goals. You never want to sell purely for tax purposes if it means derailing your investment plan.
When and When Not to Use It
Tax-loss harvesting works best if you’ve had a strong year of gains and want to soften the tax blow. It’s also great for rebalancing your portfolio by cleaning out losing positions. And if you’re in a high tax bracket, even small offsets can save you a decent amount.
But if you’re in a low tax bracket or working with small losses, the savings might not be worth the hassle.
