Tax-loss harvesting is a tax mitigation strategy that seasoned investors use to avert or reduce their tax liability. They typically do this by balancing capital losses with gains by, for example, selling investments that have decreased in value and using those losses to offset capital gains. Losses can take on different forms that include:
- Stocks you sell at a loss,
- Failed startup investments,
- Bad debts in your business.
The greater the deficit on these investments means the lower your tax liability would be on investments that have seen gains during the same period. Many investors employ tax-harvesting strategies to get as close to a zero tax rate as possible. In this article we take a look at some of the benefits and risks associated with tax-loss harvesting, and factors to consider when planning your tax-loss harvesting strategy. 
Benefits and risks of tax-loss harvesting
The greatest and most obvious benefit of tax-loss harvesting is, as its name suggests, the ability to minimize your tax liability.
Benefits
Tax-loss harvesting can also be applied to your taxable income as it can reduce the taxable amount when you have more capital losses than gains. The IRS states that if your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your income is the lesser of $3,000 ($1,500 if you are married and filing separately). But, direct saving in terms of lowering your tax liability, is not the only benefit of tax-loss harvesting. Keeping a close watch on your investments may encourage you to sell off non-growing investments with a poor outlook thus offering better risk management and the potential of reinvesting the money into more promising investments to protect the long-term health of your overall investment portfolio.
Risks
While some may see dollar signs and think of ways to use tax-loss harvesting as a way to beat taxes, this is not the case. The IRS has safeguards against trying to cash-in on the deduction with its wash sale rule, which prohibits an investor from taking a tax deduction if they sell an investment at a loss and repurchase the same investment, or a substantially identical one, within 30 days before or after the sale. You cannot deduct losses from sales or trades of stock or securities in a wash sale unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities. If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale. Another risk factor to consider when making use of tax-loss harvesting to reduce your tax liability is the market’s potential to recover. Selling securities to harvest losses may result in a temporary reduction in terms of reducing your tax liability, but if the market of the surrendered investment recovers quickly, you could miss out on bigger gains in the long term.
Best Practices for Tax-Loss Harvesting
It’s important to stay abreast of your investment portfolio to make accurate and calculated decisions about selling or keeping certain investments. Consult a tax expert that understands tax-loss harvesting, and work with them to implement a tax strategy that can work for you.
- Establish a tax-loss harvesting plan: Be proactive about the possible steps you can take and investments with the potential for surrender. This will allow you to take swift action to protect your investment portfolio.
- Monitor your investments: Review your investments regularly and identify trends. There are a number of investment tracking apps that can make this easier to do, but you can also consult with a seasoned CPA for inputs.
- Keep records of income and expenses: You cannot claim tax losses without justification thereof. Implementing accounting software to help you keep an accurate record of your gains and losses will help you make reliable submissions to the IRS.
- Be cautious when reinvesting: According to the wash-sale rule, you must wait 30 days before buying similar to the ones you’ve surrendered, this can become tricky as it also includes spouses. Making this error can result in hefty penalties.
- Consult an expert: Tax-loss harvesting can be complex – you may actually lose more money in the long run if you surrender certain investments. For this reason it is advisable to consult a seasoned expert that understands market trends to maximize the benefits.
At Fusion, our tax professionals are skilled at making accurate and timeous tax submissions to the IRS. We aim to provide you with portfolio insights to help you maximize deductions that could save you money in taxes. We can also do a risk analysis on your investment portfolio. Consult with our experts today if you require tax filing advice or assistance.
This blog article is not intended to be the rendering of legal, accounting, tax advice or other professional services. Articles are based on current or proposed tax rules at the time they are written and older posts are not updated for tax rule changes. We expressly disclaim all liability in regard to actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.
