What You Need to Know about Tax-Loss Harvesting

Not every investment will be a winner, but a strategy called tax-loss harvesting can potentially lower your tax bill. It involves selling investments at a loss to help offset capital gains that may otherwise be taxed at less favorable rates. While tax-loss harvesting won't eliminate your taxes, it may offset what you owe on your taxable investment accounts and help balance your tax exposure across your investment portfolio.

Understanding Capital Gains Tax

Capital gains are profits you make from selling certain assets, such as real estate, stocks, bonds, and digital assets like NFTs and cryptocurrencies. When you sell an asset for more than you paid for it, you may owe taxes on that gain. The amount you owe depends on several factors, including the type of asset, how long you've owned it, and how much value it accrued over time.

There are two types of capital gains taxes:

• Short-term gains – profits from selling assets you've owned for a year or less. They're typically taxed at the same rate as your ordinary income.
• Long-term gains – gains from assets sold after more than a year of ownership. These are often taxed at lower rates than short-term gains and ordinary income.

Even if your portfolio has experienced more losses than gains, you may be able to use the losses to help lower your taxes. If you have a net capital loss for the year, you can deduct up to $3,000 of that loss against your ordinary income ($1,500 if married filing separately). Losses beyond that limit can be carried forward to future tax years.

Impact of Taxes on Investment Returns

A diversified portfolio may contain tax-advantaged, tax-free, and fully taxable investment vehicles and accounts — including stocks, bonds, money market deposit accounts, municipal bond funds, and tax-advantaged or tax-free accounts. The composition of your portfolio affects your tax exposure, so it's worth understanding how each part of it is working for you.

The Basics of Tax-Loss Harvesting

Tax-loss harvesting is a strategy that may help you manage your tax liability by selling investments that have experienced losses. It can help offset capital gains by realizing capital losses, which may reduce the overall tax impact of your investment activity.

When you sell an asset for less than its purchase price, you incur a capital loss. This loss may help offset capital gains — profits from selling investments for more than their purchase price. By selling investments at a loss, you may reduce your taxable income, which could lead to a lower tax bill.

It's important to be mindful of the tax rules involved. One key example is the IRS "wash-sale" rule, which disallows a loss if you sell a security and buy the same or a "substantially identical" security within 30 days before or after the sale.

Issues to Consider Before Utilizing Tax-Loss Harvesting

Tax-loss harvesting can be a useful tool, but it comes with complexities and potential drawbacks, including:

• Wash-Sale Restrictions: If you sell a security at a loss and buy the same, or a substantially identical, security within 30 days before or after the sale, the loss is typically disallowed for that tax year.
• Short-Term vs. Long-Term Gains: When harvesting losses, it may be more valuable to focus on offsetting short-term gains, since they're taxed at higher rates. Long-term losses can offset long-term gains too, though the tax benefit may be smaller since those gains are taxed at lower rates.
• Account Limitations: Tax-loss harvesting generally isn't relevant for tax-deferred retirement accounts like a 401(k) or IRA, since losses in those accounts aren't deductible.

Capital Losses to Offset Capital Gains and Personal Income

When you sell an asset — such as stock or real estate — at a profit, that's a capital gain. A loss on such a sale is a capital loss. Capital losses can help offset capital gains and, within limits, reduce your overall taxable income. If your capital losses exceed your capital gains in a given year, the excess may offset other income, such as wages.

There are annual limits on how much you can deduct against ordinary income. Amounts above that limit may be carried forward to future years, subject to applicable rules.

An Example of Tax-Loss Harvesting

Suppose you own shares of ABC stock and XYZ stock, both held for under 12 months. If you sell ABC stock at a profit, that profit is subject to short-term capital gains tax (typically higher than long-term rates). Selling shares of XYZ stock at a loss could help offset some of that tax liability.

The realized short-term loss on XYZ stock can help offset the short-term gain on ABC stock. Any excess loss may then offset up to $3,000 of ordinary taxable income ($1,500 if married filing separately), with amounts above that carried forward to future years.

Because tax-loss harvesting involves rules and variables that are easy to misapply, please contact the office to discuss whether this strategy may be appropriate for your specific situation.

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^{For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Registered Representatives of Cetera firms may not give legal or tax advice.}