Tax Gain/Loss Harvesting
What is Tax Gain/Loss Harvesting?
Tax gain/loss harvesting is a strategy for reducing.
How Does Tax Gain/Loss Harvesting Work?
John Doe made two major
1. Sold 1,000 of Company XYZ at $25 a (originally purchased five years ago for $15 a )
2. Sold 1,000 of Company ABC at $40 a (originally purchased five years ago for $20 a )
These two transactions created $30,000 of , for which he will have to pay capital gains tax of, say, 15%, or $4,500.
In order to reduce that hefty tax bill, John Doe could also use this as an opportunity to unload some of the dog stocks that he’s been hanging onto. For instance, John Doe might own 200 of Company DEF, which he bought for $30 a and are now laying there at $15 a with little hope of recovery. If John Doe sells those , he’ll take a loss of $15 x 200 = $3,000.
This loss is tax-deductible. Thus, if John Doe wants to lower his tax bill, he might as well sell his dog stock now and reduce his taxable gains. Accordingly, instead of paying $4,500 in , John Doe would pay:
Capital Gains tax, post-harvesting = ($30,000 - $3,000) x 15% = $4,050
Looks like unloading his dogs now would save him $450 in . Note, however, that John Doe will also incur transaction fees to effect these transactions, which would reduce his savings.
Why Does Tax Gain/Loss Harvesting Matter?
Generally, the rule is that investors must net short-term gains and losses against each other, and net long-term gains and losses against each other. The typically limits the for capital losses to $3,000 a year.
In our example, we assume that John Doe is dealing with a long-term capital gains rate of 15%. Other situations might be different, but the point is that investors who have considerable obligations can offset those obligations by unloading in which they’ve lost money during the same . IRAs, 401(k)s, and other tax-sheltered plans usually do not permit tax-loss harvesting; of and ETFs, however, are well-suited for tax-loss harvesting.
It is important to note that the is aware that the deductibility of losses might tempt investors to sell at a loss, deduct the loss, and then turn around and buy the same stock again (in an effort to evade ). This practice is called a wash sale -- the disallows investors from taking deductions associated with them.