Investment losses are disappointing, but in certain circumstances they may have a role in tax planning. Tax-loss harvesting involves selling an investment that has declined in value and realizing the loss for tax purposes.
The strategy can help investors manage taxable investment gains, but it is subject to tax rules and does not turn a poor investment into a profitable one.
How the strategy works
Suppose an investor buys shares for $5,000 and later sells them for $4,000. The sale creates a $1,000 capital loss before considering fees and other adjustments.
If the investor also has capital gains from other investments, eligible losses may offset those gains. If capital losses exceed capital gains, individuals may generally deduct up to $3,000 of net capital loss against ordinary income in a year, or $1,500 if married filing separately. Remaining losses may generally be carried forward, subject to applicable rules.
Tax treatment depends on the investor's circumstances, the type of account, and the nature of the transactions.
The wash-sale rule
One important restriction is the wash-sale rule. In general, a taxpayer cannot claim a loss on a security if substantially identical securities are bought within 30 days before or after the loss sale.
The rule can also apply when a spouse or a controlled corporation makes the replacement purchase. The IRS also addresses purchases in an IRA or Roth IRA, which can create particularly unfavorable outcomes.
Investors should not assume that buying the same investment in another account avoids the rule.
Don't let taxes drive every decision
A tax benefit should not be the only reason to sell an investment. Investors should consider whether the holding still fits their strategy, whether a replacement investment has different risks, and whether transaction costs or market movements could outweigh the tax benefit.
Tax-loss harvesting can also create recordkeeping responsibilities. Investors should keep trade confirmations, cost-basis records, and documentation of replacement purchases.
Get qualified tax guidance
The rules can be complex, especially when an investor makes frequent trades or holds the same security across multiple accounts. A qualified tax professional can help evaluate the implications before a transaction is made.
Bottom line: Tax-loss harvesting may help manage taxable gains, but the wash-sale rule and other tax requirements matter. Investors should understand the rules before selling and repurchasing securities.
This article is for educational purposes and is not tax advice.
