Reduce Your Taxes with Tax-Loss Harvesting

By Mark Yatros

The good news: Your investments went up this year.

The bad news: Your tax bill may be going up, too.

However, you may be able to lower your tax burden through tax-loss harvesting.

But what exactly is tax-loss harvesting, and how do you know if it will benefit your tax situation? Read on to learn the basics of tax-loss harvesting. We'll explore its benefits and how to use it effectively. If used wisely, tax-loss harvesting can lower your tax burden and improve your financial picture.

What is tax-loss harvesting?

Tax-loss harvesting is selling investments at a loss to offset gains from other investments. When you sell an asset for less than you paid for it, that loss can be used to reduce your taxable capital gains on other profitable investments, potentially lowering your overall tax bill.

This strategy is especially helpful toward the end of the year when you can evaluate your portfolio and see which investments have appreciated and which have lost value. By “harvesting” these losses, you can reduce your capital gains taxes for the current tax year, which can be particularly useful if you’ve had a strong year in the markets.

It’s important to note that not all investments can be used for tax-loss harvesting. Losses in tax-advantaged accounts, like 401(k)s and IRAs, do not count for tax-loss harvesting because gains and losses in these accounts aren't taxable until withdrawal.

How tax-loss harvesting works

Tax-loss harvesting provides benefits in a few different ways:

Offsetting capital gains

The primary purpose of tax-loss harvesting is to offset capital gains. For example, if you’ve sold some stocks at a profit, you can balance those gains by selling underperforming assets at a loss. This reduces the taxable amount of your capital gains and can lower the taxes you owe.

Reducing ordinary income

If your losses exceed your gains, you can use up to $3,000 of the excess to offset your ordinary income, like wages or business income. This deduction can help lower your taxable income for the year and may put you in a lower tax bracket. 

Carrying over losses to future years

If your losses exceed your gains and you've used the $3,000 deduction against ordinary income, you can carry the remaining losses forward to future tax years. So, even without gains to offset now, tax-loss harvesting can help reduce future taxes.

Is tax-loss harvesting right for you?

Tax-loss harvesting isn’t ideal for everyone, so it’s important to determine if it will benefit your specific situation:

Evaluate your portfolio

Start by reviewing your portfolio to identify investments that are currently valued below their original purchase price. If these underperforming assets are too risky or misaligned with your goals, they may be good candidates for tax-loss harvesting.

Consider your income and tax bracket

Tax-loss harvesting is generally better if you’re in a higher tax bracket because you pay a larger percentage on capital gains. If you expect big gains this year or have high taxable income, this strategy can help reduce your tax burden.

Understand account limitations

Remember that tax-loss harvesting applies only to taxable accounts. Losses in tax-advantaged accounts, such as IRAs and 401(k)s, won’t yield tax benefits because gains in these accounts aren’t taxable.

Pro tip: If you’re unsure about tax-loss harvesting, consult a financial advisor or tax professional. My colleagues and I at Allegiant Wealth Strategies are here to help you make decisions tailored to your goals. You can reach us at 269-218-2100 or visit our website.

Steps for tax-loss harvesting

If you decide that tax-loss harvesting is a good fit for you, here’s a step-by-step guide to help you implement it effectively:

Identify losses in your portfolio

Start by listing the investments in your taxable accounts that have decreased in value since you purchased them. Focus on assets you’re willing to sell, especially those that no longer meet your investment goals or have underperformed significantly. 

Sell losing investments

Once you’ve identified which assets to sell, go ahead with the sale to realize the loss. Keep in mind the “wash-sale rule,” which prevents you from claiming a deduction if you buy back the same or a substantially identical investment within 30 days of the sale. This rule applies to pre- and post-sale periods, so avoid repurchasing those assets during this time frame. 

Reinvest strategically

After selling, reinvest in different assets so your portfolio remains diverse while your investment strategy stays on track. For example, you could buy similar but not identical assets while complying with the wash-sale rule. Reinvesting carefully can help balance your portfolio as you continue working toward your financial goals. 

Pro tip: Set calendar reminders for the 30-day wash-sale period to avoid accidentally repurchasing the same investment and forfeiting your deduction.

Common mistakes to avoid in tax-loss harvesting

While tax-loss harvesting can be a useful tool, there are a few common mistakes to watch out for:

Violating the wash-sale rule

As mentioned earlier, the wash-sale rule means you can't repurchase the same or similar investment within 30 days before or after the sale. Make sure to track your transactions and avoid violating this rule. If you do, your tax deduction will be disqualified, reducing the strategy's potential benefits.

Focusing solely on tax benefits

While tax-loss harvesting can reduce your tax bill, ensuring it aligns with your overall investment strategy is essential. Selling an asset simply to harvest a loss may not make sense if it disrupts your portfolio or results in an unfavorable reinvestment. Instead of using it as a quick fix, make sure tax-loss harvesting fits into your broader financial plan. 

Overdoing it

Although tax-loss harvesting can be beneficial, using it too often could have a negative impact on your portfolio’s performance. Selling too often may cause you to miss out on future growth opportunities. Use tax-loss harvesting sparingly and as part of a balanced approach to avoid over-harvesting.

Pro tip: Use tax-loss harvesting as part of a broader investment strategy, not as a standalone tax tactic. Review your portfolio regularly to ensure it aligns with your long-term financial goals.

Is tax-loss harvesting worth it for you?

Tax-loss harvesting is not a one-size-fits-all strategy. It works best in an annual financial review or investment check-in when you can evaluate how it impacts your overall portfolio.

Working with a financial advisor can make the tax-loss harvesting process easier and more effective. My colleagues and I at Allegiant Wealth Strategies are here to help you understand if this strategy aligns with your financial situation, guide you through the steps, and help you comply with IRS rules. You can reach us at 269-218-2100 or visit our website.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to ensure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Allegiant Wealth Strategies offers securities and advisory services through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. Allegiant Wealth Strategies has offices in Battle Creek and Portage, Michigan, from which we serve Calhoun County, Kalamazoo County, and Kent County (Grand Rapids). The Allegiant Wealth Strategies team offers no-obligation financial planning consultations; call 269-218-2100 or contact us here.