Tax-loss harvesting involves the selling of investments that have decreased in value, ie, losing positions, in order to offset capital gains in winning stock positions. The capital losses incurred can directly offset capital gains on a pound-for-pound basis or dollar-for-dollar according to the IRS.
This means if you have capital gains that pushed you into a higher tax bracket, selling losing stocks could pull your taxable income back down.
The end of each calendar year always comes with a narrative on financial media surrounding tax loss harvesting, and portfolio rebalancing that warrants a closer look from retail. We hear the tales of why markets may be moving in one direction or another, and these topics always tend to rear their heads, but it is not as complicated as may be first thought.
Adjusting your investment portfolio by selling underperforming stocks can be a strategic way to enhance your returns while also reducing your tax liability.
As an example, Boeing shares lost ~30% through 2024, whilst Tesla gained 60%.
If you had both Boeing (NYSE: BA), and Tesla stock (TSLA) in your portfolio, the tax on gains from Tesla could be reduced by selling part of your Boeing holdings.
Considerations and Limitations
Navigating these strategies effectively requires careful planning and consultation with a financial advisor to maximize the potential advantages while ensuring compliance with tax regulations.
The decision to sell underperforming stocks should be strategic, factoring in potential tax savings and the reallocation of capital into more promising investments.
Beyond offsetting capital gains, if your losses exceed the total gains, taxpayers are allowed to deduct up to $3,000 ($1,500 if married filing separately) from their ordinary income. This deduction can provide significant savings, particularly for those in higher tax brackets.
It is important to note that short-term capital gains are taxed as ordinary income, with the highest US tax rate in 2024 being 37%, along with a potential 3.8% investment income surcharge.
Investors should be mindful of several limitations, including the wash-sale rule. This rule mandates a 30-day waiting period before repurchasing a sold security or a substantially identical one to claim the tax loss. However, this rule offers some flexibility with ETFs and mutual funds, as there are grey areas regarding what constitutes “substantially identical,” particularly if different indexes are tracked.
