What is Tax Loss Harvesting?
Amherst, NH Resident Looks for Ways to Reduce Capital Gains Tax
Tax loss harvesting is an effective strategy for investing that you can use all year long in an effort to reduce the amount of capital gains taxes owed on your earnings. This practice is offsetting capital gains with capital losses and can make a big difference in the amount of taxes owed each quarter from the sale of your investments. Not all investments are going to perform as well as you like. When you sell one for a profit, while also selling an under-performing investment at a loss, this will help to balance the taxes you owe in capital gains.
An Amherst resident was selling some of her investments for a down payment on a new home. Realizing that she had made a great return on her money, she was concerned about the capital gains taxes that she would owe the IRS.
Offset Capital Gains with Losses to Lower the Amount of Taxes Owed
When you sell an investment for a profit, you will be taxed on this profit. The tax rate will be determined by whether the investment falls under long or short-term capital gains, with short-term capital gains being taxed at a higher rate. The IRS requires this tax to be paid through an estimated tax payment in the quarter that the profit was realized. This can significantly chip away at the profit from your investments. One way to offset some of the taxes owed on your profitable investments is by simultaneously selling those under-performing investments that may be seeing a loss. The amount of money lost from your investment can then be used to directly reduce the taxes owed on your capital gains.
Considerations Before Tax-Loss Harvesting
This strategy does not work with retirement accounts, such as a 401(k) or an IRA. Losses generated cannot be deducted from a tax-deferred account. Long-term losses will first be applied to long-term gains, and vice versa short-term losses will first be applied to short-term gains. If there is an overage, the losses can then be applied to the other. You should be aware of a wash-sale rule which prohibits you from selling an investment at a loss, using this money to offset capital gains, only to again buy the same investment within 30 days.
The Amherst resident now has a better understanding of how her investment gains will be taxed and strategies that she can implement to reduce some of the taxes owed.