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Not every investment will pay off. Fortunately, there is a silver lining to a losing investment: you may be able to use the loss to reduce your tax liability and better position your portfolio in the future. This is known as tax-loss harvesting, one of countless tax-smart tactics investors should learn about. Talk to an expert today to learn more about individual tax preparation in Phoenix.
Tax-loss harvesting: what is it?
The timely sale of securities at a deficit to balance the total capital gains tax owed on the sale of lucrative assets is known as tax-loss harvesting. This technique is widely used to minimize short-term capital gains, typically taxed more than long-term ones, to protect portfolio value while decreasing taxes.
Tax loss harvesting is often referred to as tax loss selling. A lot of investors use this method at the end of the year as they evaluate their portfolios’ annual performance and the impact on their taxes. An investment with the lost value might be sold to obtain credit against earnings obtained in other assets.
Tax-loss harvesting is a technique for lowering overall taxes. A reduction in the worth of Security A could be sold to counterbalance a rise in the value of Security B, thereby reducing Security B’s capital gains tax burden. Investors can save a lot of money by using the tax-loss harvesting approach.
Maintaining your portfolio
Selling an asset at a deficit upsets the portfolio’s balance. Investors with properly formed portfolios substitute the asset sold with a similar asset after tax-loss harvesting to retain the portfolio’s asset mix and planned risk and return levels. Investors should avoid purchasing the same asset they recently sold at a loss, as this may break the IRS wash-sale rule.
The wash-sale rule
For tax purposes, the wash-sale rule instructs an investor to avoid purchasing the same stock sold at a loss. A wash sale sells one security, followed by purchasing a nearly identical stock or securities within 30 days. If a transaction is deemed a wash-sale, it is not eligible for use to offset capital gains. If wash-sale laws are violated, regulators may levy fines or limit the individual’s trading.
In a tax-loss harvesting strategy, ETFs that follow the same or similar indexes may substitute one another without breaching the wash sale rule. If you sell one S&P 500 index ETF at a loss, you can reinvest the proceeds in another S&P 500 index ETF.
For more information, talk to an expert today.
