When the market dips, it’s easy to focus solely on the account value, but there may be a strategic way to turn those downward moves into a benefit for your tax bill.
In this brief video, we pull back the curtain on how tax-loss harvesting works in practice and how it could be used to help you keep more of your hard-earned money over the long run.
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Transcript
How Tax-Loss Harvesting Can Offset Capital Gains
If you sold an investment at a profit this year, you will likely owe tax on that gain. If you’re also holding something that’s down, selling it can cancel out part of that bill. The rules for doing it are specific, and the opportunity to do this generally shows up when markets move, not necessarily in the last week of December.
Hi, I’m Matt Donahue, a financial planner at Thrive Wealth Management. I want to walk through how this works in practice.
If you sell an investment from a taxable account for less than you paid, you have a loss.
How Investment Losses Can Reduce Taxable Gains
The IRS lets you use that loss to cancel out the taxable profits you made selling something else the same year. But what if you don’t have any profits to cancel out, or your losses add up to more than your profits? Then up to $3,000 of the leftover loss can come off your regular income, the same income your paycheck gets taxed on. And if you still have more loss than that, it doesn’t disappear.
How Capital Loss Carryforwards Work
It carries into the next year, and the next year after, until you’ve used it all. Keep in mind that this only works in a regular brokerage account. Your 401(k) and IRA aren’t taxed year to year, so there’s nothing to harvest there.
What Is the Wash Sale Rule?
Here’s where this may go wrong. If you sell at a loss and buy the same investment back within 30 days, you can’t use that loss. The IRS sees the two trades as one continuous position, and your deduction has to wait.
It’s called the wash sale rule. But some people miss something important: those 30 days run in both directions, before the sale and after it.
Understanding the 61-Day Wash Sale Window
So you’re really looking at a 61-day stretch where that purchase can’t happen. And it follows your household, not just the account. If your spouse bought the same investment in their account, that counts.
If dividends are automatically buying you more shares and nobody turned that off, that counts too. People hear this and assume it means going to cash for a month. Not necessarily.
Can You Reinvest After Tax-Loss Harvesting?
You can put the money into something that fills a similar role, as long as it isn’t the same investment and the loss still counts when you file. If your goal is to lower your tax bill (and whose isn’t?), we view tax-loss harvesting as something to watch all year, not just in December. What it’s worth to you depends on everything else happening on your return.
When to Consider Tax-Loss Harvesting
Are you unsure about what you’ve sold at a profit this year, or what losses you had sitting from prior years? Our team at Thrive Wealth Management would be glad to look at it with you. Reach out at 215-376-5530 or contact us via our website, thrivewealth.com. Thanks for watching.
Frequently Asked Questions About Tax-Loss Harvesting
How does tax-loss harvesting work?
Tax-loss harvesting can be used to lower your taxes by using investment losses to cancel out investment gains in the same tax year. If your losses exceed your gains, up to $3,000 can offset your ordinary income, and anything beyond that carries forward indefinitely. It applies only to taxable brokerage accounts, not retirement accounts, and certain conditions apply.
What is the wash sale rule, and how long do you have to wait?
The wash sale rule disallows your loss if you buy the same or a substantially identical investment within 30 days of selling it. The window runs both directions, giving you a 61-day period total. It applies across your household, including:
- Your spouse’s accounts
- Your IRA
- Automatic dividend reinvestment
If you are unable to take advantage of tax-loss harvesting due to the wash sale rule, all is not lost. The amount of your loss can be added to the cost basis of the replacement security, to help reduce future taxable gains on that position.
Can tax-loss harvesting benefit a 401(k) or IRA?
No. Tax-loss harvesting works only in taxable brokerage accounts, since gains and losses inside retirement accounts aren’t taxed year to year. And keep in mind that buying a security inside an IRA after selling it at a loss elsewhere can permanently disallow the loss for tax-loss harvesting purposes, if both transactions occur within the defined timeframe. Advisors at Thrive Wealth Management coordinate harvesting across a household’s full account structure to guard against that outcome.
This material is provided for informational and educational purposes only, should not be viewed as an exhaustive discussion of the topics presented, and should not be construed as individualized advice for any viewer’s personal circumstances. For guidance on how these matters may impact your financial plan or investment portfolio, please contact your Thrive Wealth Management, LLC representative. While the information presented is believed to be factual and up to date, Thrive Wealth Management, LLC does not guarantee its accuracy and, due to various factors, including but not limited to changing laws and regulations, this information is subject to change. All expressions of opinion reflect the judgment of the speaker as of the date of publication. Thrive Wealth Management, LLC is not a law firm or an accounting firm, and no content contained herein should be construed as legal or accounting advice. Please consult with the qualified professional(s) of your choosing for legal and accounting advice. Please visit https://thrivewealth.com/disclosure for additional information regarding the professional designations and credentials discussed. Professional designations and credentials do not guarantee success or any particular investment or financial outcome. Past performance does not guarantee future results. All investing comes with risk, including risk of loss.
