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You hate to see an investment go south, but it is almost impossible to pick a winner every time, or to know the right time to sell, so that you don’t take a loss. But even a losing investment can have a good side, as you might be able to use the loss to lower your tax burden. It’s a popular strategy known as “tax loss harvesting,” and just about any investor can take advantage of it. The concept is pretty straightforward—you sell the investment that is declining and reinvest in something more consistent with your goals. If you recognize a tax loss, you can use it to reduce your taxable income.
Here is how it typically works:
- You recognize a capital gain on some investment, which will necessarily increase your tax liability
- You have other investments that have produced a loss (you sold them for less than you paid for them)
- You use the losses to offset the capital gains, so that your tax burden is not increased
However, it is not necessary that you have capital gains to offset—you can also get a tax break against ordinary income. However, there is a limit on how much capital loss can be used in any tax year–$3,000. But you can carry the capital loss forward and use up to $3,000 per year in subsequent years.
Some Caveats
Before you consider using tax loss harvesting to reduce your tax obligation, consider the following:
- Losses and gains are categorized as “long term” and “short term.” A long term loss must first be applied to a long term gain. The same holds true of short term losses—they must first be applied to short term gains. Any excess loss may be applied to either type of gain.
- You cannot use tax loss harvesting for losses incurred in retirement accounts, because those losses are not deductible.
- Watch out for the “wash sale,” where a loss is not allowed if you buy the same or a “substantially identical” investment within 30 days of the sale (either before or after)
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for special individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. No strategy assures success or protects against loss. Investing involves risk including loss of principal.
Contact The Pinnacle Financial Group
At The Pinnacle Financial Group, we have provided professional risk management advice to individuals and businesses in New York and Connecticut for two decades. We understand the critical role insurance planning plays in your financial future. We will carefully explain your options and the different strategies available to you, so that you can make the right decisions for you and your loved ones.
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