What Is Tax-Loss Harvesting and How Can It Benefit Savvy Investors?

Tax-loss harvesting is a sophisticated tax strategy used by investors to capitalize on the potential benefits of losses in their investment portfolios. It involves a systematic approach to selling underperforming investments to offset realized capital gains, thereby reducing taxable income. This strategic maneuver not only serves to lower immediate tax liabilities but also offers the opportunity to rebalance portfolios and optimize long-term investment strategies.

The process begins with a thorough analysis of the investor's current portfolio. The investor should identify investments that have depreciated in value, resulting in unrealized capital losses. These underperforming assets are strategically sold to realize losses, providing an opportunity to leverage these losses for tax purposes. A sale will lock in the losses, which can then be used to offset capital gains realized elsewhere in the portfolio.

One of the primary advantages of tax-loss harvesting is its ability to mitigate capital gains taxes. By strategically timing the sale of depreciated assets to coincide with the realization of capital gains in other parts of the portfolio, investors can effectively neutralize or reduce the tax impact of their gains. This can be particularly beneficial for investors in higher tax brackets or those with significant capital gains.

Furthermore, tax-loss harvesting offers the flexibility to offset not only capital gains but also ordinary income. If the realized losses exceed the total amount of capital gains in a given tax year, investors can use the remaining losses to offset up to $3,000 of ordinary income ($1,500 for married taxpayers filing separately). Any unused losses can be carried forward to future tax years, providing a valuable tax-planning tool.

However, implementing a tax-loss harvesting strategy requires careful consideration of several factors. Investors must be watchful of the wash-sale rule, which prohibits the repurchase of the same or substantially identical securities within 30 days before or after selling them at a loss. Violating this rule can result in the disallowance of the loss for tax purposes, negating the intended tax benefits. Wash-sale rules apply not only to purchases of substantially identical securities within the same account but also to purchases of substantially identical securities acquired in all accounts owned or controlled by you, your spouse, or partner, including tax-deferred accounts, such as IRAs and 401(k) plans. Additionally, if you are not selling the entire position, proper identification of the most advantageous tax lots is important.

Investors must also consider the holding periods of their investments, as short-term losses are taxed at different rates than long-term losses. By strategically selecting investments with the most advantageous tax treatment, investors can maximize the tax benefits of their harvesting efforts.

In conclusion, tax-loss harvesting is a powerful tool for investors seeking to minimize tax liabilities and optimize portfolio performance. By systematically harvesting losses, investors can strategically manage their tax obligations while maintaining their long-term investment objectives.

However, it is essential to consult with a tax advisor and a qualified investment professional to ensure that the strategy is implemented effectively, compliant with current tax rules, and in alignment with individual financial goals and circumstances.

If you have any questions regarding tax-loss harvesting, please reach out to the First Bank Wealth Management Team.
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Ron Manning, CFA, CAIA, CIPM, is a Portfolio Manager II for First Bank Wealth Management. With over 20 years of experience in financial services and a deep knowledge of investment portfolio management across both traditional and alternative asset classes, you may contact Ron Manning at (925) 746-2800 or via email at [email protected].