Selling a Stock: Justifiable Motives and Potential Pitfalls Today
Tax-Loss Harvesting: A Strategy for Reducing Tax Liabilities
In the world of investments, losses can sometimes be turned into a silver lining—especially when it comes to tax-loss harvesting. This strategy, which involves selling securities at a loss in a taxable account, can help investors offset capital gains and reduce their taxable income.
When an investment underperforms, the loss incurred can be utilised in several ways. For instance, $3,000 of the loss can be used in a particular year to offset ordinary income, while the remainder, if any, can be carried forward to the next year and beyond.
To execute tax-loss harvesting, you first identify investments in your taxable accounts that have declined in value. These underperforming assets are then sold, realising a capital loss. The realised losses can then be used to offset any capital gains made from selling other investments. If your losses exceed gains, you can use up to $3,000 of the remaining loss to offset ordinary income each year.
Any unused losses beyond $3,000 can be carried forward indefinitely, ready to be used in future years to offset capital gains or income. To stay invested while harvesting losses, it's important to reinvest the proceeds into a similar, but not substantially identical, asset. This is to avoid the IRS wash-sale rule, which disallows the loss deduction if you buy back the same or a very similar investment within 30 days before or after the sale.
Tax-loss harvesting is most effective for investors in higher tax brackets and only applies to taxable brokerage accounts—not tax-deferred accounts like IRAs or 401(k)s, as gains and losses in those accounts are not currently taxable. The long-term benefit is that by reducing your tax bill annually, you free up more money to reinvest, potentially increasing your portfolio's after-tax growth over time.
It's important to note that while a market downturn can cause solid companies to trade at a lower price than the start of the year, selling a stock due to a broad market trend is generally not advisable. On the other hand, selling a stock due to a company's clear struggles can be advisable, especially if it's a pharmaceutical company underperforming due to failed drugs or lack of FDA approval. Similarly, a tech stock consistently missing earnings expectations and hemorrhaging cash may warrant selling at a loss.
In conclusion, tax-loss harvesting is a strategy that can enhance tax efficiency, help manage tax liabilities in volatile markets, and potentially improve long-term portfolio growth. By understanding this strategy and its implications, investors can make informed decisions about their taxable investments and maximise their returns.
Key points:
- Offsets capital gains and up to $3,000 of ordinary income per year.
- Must avoid repurchasing identical assets within 30 days (IRS wash-sale rule).
- Applied only in taxable accounts, not retirement accounts.
- Benefits increase with higher tax brackets and realised capital gains.
- Losses beyond limits can be carried forward indefinitely.
Tax-loss harvesting is a valuable strategy for personal-finance, as it allows investors in higher tax brackets to offset up to $3,000 of ordinary income per year, in addition to capital gains. However, to reap the benefits, it's essential to avoid repurchasing identical assets within 30 days, as illustrated by the IRS wash-sale rule. This strategy is applied only in taxable accounts, not retirement accounts like IRAs or 401(k)s, and the long-term benefit is increased portfolio growth due to the reduced tax bill that allows for reinvesting more money.
