Tax minimization in your portfolio is inherently a good strategy. Tax-loss harvesting is a strategic way to minimize taxes on investment gains by selling assets at a loss to offset taxable gains.  You are only taxed on net capital gains, so any realized losses can lower your tax bill. By utilizing this method, investors can effectively reduce tax liability and improve their portfolio’s overall performance, but it takes careful timing and attention to IRS rules to maximize benefits.

When to Sell Losses

Tax-Loss harvesting aims to use investment losses to reduce relevant taxable income. Here are ideal times to consider selling:

• Offsetting Capital Gains: Selling a loss can offset taxable gains from other investments, reducing your capital gains tax. For example, if you’ve sold appreciated stocks, you can offset that gain with a loss from other assets.
• Limit Annual Capital Losses: While you can only use up to $3,000 in capital losses to offset ordinary income per year, any excess can be carried forward to future tax years. Therefore, selling could help manage future tax liabilities if you have losses exceeding that limit. (Based on current IRS rules)
• Strategic Rebalancing: Sometimes, you may want to sell a losing investment because it no longer fits your overall strategy. In this case, tax-loss harvesting offers an opportunity to reposition your portfolio while reducing tax consequences.
• Managing Ordinary Income: The IRS allows you to use up to $3,000 of capital losses annually to offset ordinary income, such as wages or self-employment income. This is particularly beneficial if your capital losses exceed capital gains, as the excess can directly reduce your taxable income. If your losses exceed the $3,000 limit, the remainder can be carried forward to future tax years. (Based on current IRS rules)
• Offsetting Dividend and Interest Income: Capital losses cannot directly offset dividend and interest income, as these are typically taxed as ordinary income or qualified dividend income. However, reducing overall capital gains or ordinary income through loss harvesting can lower your taxable income and, by extension, reduce the effective tax on your dividends and interest.

When to Buy Gains

Once you’ve sold a losing investment for tax purposes, carefully reinvesting can help maintain your portfolio’s exposure and avoid IRS pitfalls:

• Avoiding the Wash Sale Rule: The IRS disallows the tax benefit if you repurchase the same or a “substantially identical” security within 30 days before or after selling it at a loss. To avoid this rule, consider buying a similar asset with different exposure (e.g., a different ETF in the same sector).
• Reinvesting Strategically: Use the proceeds from your sale to buy assets aligned with your long-term asset allocation strategy. This helps maintain market exposure while avoiding the tax consequences of a wash sale.
• Capitalizing on Market Conditions: Tax-loss harvesting is especially beneficial during market downturns. Selling during these periods allows you to reposition your portfolio with assets that have recovery potential, positioning you for future gains while minimizing your current tax obligations.
• Know the rules: One more time, know the rules! Since tax-loss harvesting requires knowledge of both market conditions and tax laws, working with a financial advisor and conferring with the IRS website or account can help to maintain compliance with IRS rules.

Best Practices for Tax-Loss Harvesting

• Year-Round Harvesting: While year-end is a common time to review for tax-loss harvesting, monitoring your portfolio year-round can help you capitalize on losses as they occur, especially in volatile market years, like election years.
• Prioritizing Long-Term Goals: While reducing taxes is important, long-term investment strategy should remain the primary focus. Avoid letting short-term tax considerations disrupt your broader financial goals.
• Understanding IRS Rules for Offsetting Different Types of Income: Because tax-loss harvesting intersects with complex tax regulations, consulting with a financial advisor or tax professional can help ensure you maximize benefits and adhere to IRS guidelines.

Conclusion

When implemented correctly, tax-loss harvesting, which requires careful timing and understanding of the rules, can significantly impact your portfolio’s tax efficiency and overall growth potential. By knowing when to sell losses, reinvest prudently, and offset different types of income, you can maximize tax savings while advancing your long-term financial objectives.

Now, how do I find potential candidate losses to sell? WealthFluent can help ensure this strategy takes minimal work to implement, with detailed and clear gain/loss data and views showing which accounts are taxable in your portfolio.