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Losing money is not anyone’s investment plan, however a well-diversified portfolio will usually contain some investments that have lost value. A silver lining in having losing investments is that you may be able to use them to lower your tax liability. In this article, we will look at not only using your losses to offset your gains, but also realizing gains at the correct time to reduce your tax liabilities associated with these positions.

The key to an effective tax harvesting strategy is to evaluate your investments and your goals with these investments combined with creating effective tax strategies to minimize your tax liability without altering your investment diversification strategies.

The general principle behind tax harvesting is fairly straightforward and is generally lining up your gains and your losses. If you have already sold a stock this year for a large gain then you generally want to sell a stock for a loss to offset that gain and minimize your tax liability. However, below are some more in depth ideas for tax harvesting.

Short-term versus long-term gains and losses

Long-term capital gains (investments held longer than one year) are taxed at either 0%, 15%, or 20% depending on your income, while short-term capital gains are taxed at your ordinary income rate, which could range anywhere from 10% to 37%. Your short-term and long-term capital gains do get netted together, so it is important to remember that if you are in the 37% tax bracket and have a short-term gain, you can offset this 37% tax by selling a long-term stock at a loss. Even though the long-term stock is taxed at a lower rate, it can offset ordinary short-term capital gains.

When capital losses exceed capital gains for the year, a taxpayer is allowed to deduct $3,000 in losses with the remaining losses carried forward to offset future gains. Therefore, even if you do not have any capital gains, it may be beneficial to sell a long-term stock at a $3,000 loss and use that capital loss to offset ordinary income.

Should I consider gain harvesting?

Whether it is in retirement, the result of a business loss or a net operating loss, or another reason, sometimes your taxable income is lower than other years. This may be the time to consider selling stocks at a gain and taking advantage of the low tax bracket that you are in. In 2018, capital gains are taxed at 0% if your income is $38,600 or less if single and $77,200 or less if married filing jointly. This means if your income is under these thresholds, you can sell investments at a gain and not pay any federal tax on that gain. Therefore, if your income is not normally under these levels, but it is for some reason in one year, then you want to sell these stocks in that year tax-free.

Beware of wash sales

Once you sell an investment for a loss, make sure that you do not buy that investment back within 30 days. If you buy that investment back within 30 days, the original loss is disallowed to prevent taxpayers from claiming artificial losses. One way to avoid a wash sale of an individual stock is to invest with exchange-traded funds (ETF). The IRS does not consider ETFs that track different indexes to be substantially identical, therefore one ETF can be replaced with another ETF that is highly correlated but tracks a different index.

Harvesting gains and losses regularly and proactively can save you money over the long run, effectively boosting your after-tax return. It is important to consider all aspects of your tax return when trying to harvest gains and losses.

Contact Us

If you need assistance or have questions about harvesting gains and losses and general tax planning, Selden Fox can help. Our tax team has considerable experience and can assist in your tax planning and tax return preparation. For additional information please call us at 630.954.1400 or click here to contact us.

John T. Wojcik, CPA, MST, CVA

John is a tax manager and Certified Valuation Analyst. John works with a variety of the firm’s clients, including individuals, family businesses, business owners, and closely held businesses. He provides tax planning, research, consulting, and compliance services. He earned his bachelor's degree in accounting and finance from Illinois State University and his MST in taxation from Northern Illinois University - College of Business.