It should come to exactly no one’s surprise that investing comes with risk.
It doesn’t matter what you’re investing in: stocks, real estate, bonds, or anything else under the Sun. All investments carry risk, and if you’re a seasoned investor, you’re well aware of the potential for loss that comes with every financial decision like this.
Regardless what your long-term investing goals are, you’re inherently speculating. There are potential risks and rewards that you’re weighing when you put your money on the line—and ultimately, you’re making an educated guess. Of course, your decisions can be determined by your investing experience and financial goals (which may mean you don’t invest at all), but regardless—you never know. Even the soundest markets have turned a loss.
Nobody wants to lose money, but it happens all the time.
Of course, we’re not trying to scare you away from it. We just mean to underscore the very real nature of investing before getting to a little secret, which you may not yet have experienced.
If you play the investment game, there’s always the chance you may lose. But if you play the right tax strategies, you can still claim a small victory.
How so, you may ask?
Well, let’s take a few minutes to go over something called tax-loss harvesting. We’ll review the tax-loss harvesting basics and some of the benefits of this tax tool before reviewing how you can actually employ this strategy.
Tax-Loss Harvesting: The Basics
While you may have never heard of tax-loss harvesting, it’s a pretty common tax strategy—especially among investors and those with high incomes and a lot of assets. This strategy can help you transform market volatility into a positive outcome, so let’s just get started with a simple definition.
Tax-loss harvesting involves intentionally generating losses in your taxable accounts by selling off investments that have lost value.
Don’t worry; we’ll clarify! Let’s say you purchase many shares of a stock, totaling $10,000. When you purchase those stocks, that value—$10,000— is essentially locked in until you sell. During the time you own the stock, the value may go up or down, but as far as Uncle Sam is concerned, you haven’t generated any gains or losses.
However, all this changes once you choose to sell this stock. If that stock has gone up in value and you end up selling it for $12,000, you have generated what’s known as a “capital gain.” Congratulations! Keep in mind, though, that capital gains are taxable, so that taxable account will register as having gained $2,000.
On the other hand, if your $10,000 has fallen to $9,000 by the time you decide to sell, you’ve lost $1,000. In this case, the IRS will allow you to use that $1,000 loss to offset your gains in any other investment accounts. Or, if that loss is much higher than anything you’ve gained anywhere else, you can apply it toward your ordinary income (up to $3,000)!
Advantages of Tax-Loss Harvesting
While everyone may have their own nuanced reasons for employing tax-loss harvesting, they mostly boil down to one purpose: deferring a tax burden.
Of course, you need to remember that you aren’t getting rid of your tax burden forever. Instead, you’re making a calculated decision to cut your losses in just the right accounts—at the right times—to maximize your benefit on your taxes in a certain year.
After you cash out the investments you’ve earned losses in, you can write off those losses against your gains—or your income!
Become a Tax-Loss Harvesting Expert
While the concept of tax-loss harvesting is pretty easy to pick up, it’s not quite as easy to master. This is why it’s always a good idea to be working with a financial advisor. With that said, there are a few basics tips you can use to get started.
Tax-Loss Harvesting and You
The truth is, tax-loss harvesting isn’t for everyone. However, if you think it might make sense for your situation, try having a chat with your financial advisor about it and see what they think.
From there, you can start turning your losses into gains—and reducing your tax burden. It won’t erase your tax debt, but it can make a serious difference in how much you pay come Tax Day. And that sounds pretty sweet to us.
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