At first glance, the term “tax-loss harvesting” seems like a trio of unrelated words put together. But if you think about it in context, it makes total sense. Tax-loss harvesting is the practice of selling securities at a lower market value than your cost basis (AKA the price at which you bought them). In short, you’re choosing a particular position in your stock market portfolio that’s in the red, and selling it before you have the chance to profit.
You may be wondering, Why on Earth would I do such a thing? Because of capital gains taxes.
How capital gains taxes tie into tax-loss harvesting
To understand the tax-loss selling tactic, you need a super quick briefing on how capital gains taxes work.
There are two types of capital gains:
- short-term (securities you held for a year or less before selling) and long-term (securities you held for more than a year before selling).
- Long-term capital gains are taxed at a lower rate than your ordinary income. Depending on your salary, you could get a 0–20% tax for any profit you earn on the sale.
However, short-term gains are taxed at the same rate as your income, which ranges from 10–35% in 2020. Regardless of what you earn, that’s a hefty chunk out of your returns. No one likes the idea of giving Uncle Sam upwards of a third of their capital gains.
That’s exactly where tax-loss harvesting comes into play.
Just like you get taxed for your capital gains, you can get a tax write-off for your capital losses. You can claim up to $3,000 of capital losses in 2020 (or $1,500 for those who are married but filing separately). This helps to offset any taxes you might incur from your gains.
Tax-loss harvesting is a strategy that many investment professionals use to offset capital gains taxes for their clients. If you’re an individual investor who’s earning a lot of profit in the stock market throughout the year, you’ll want to consider selling some securities while they’re still in the red to limit (or eliminate) how much you owe come tax season.
For big-time investors, $3,000 probably won’t be enough to offset taxes owed for short-term capital gains. However, those who are investing small to medium chunks of change for short-term investments are likely to notice a difference in their tax calculations.
Another way to make use of tax-loss selling… Finish reading the article here
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