Tax-loss harvesting is an investment strategy used to minimize taxes on capital gains by selling securities at a loss. This technique allows investors to offset capital gains with capital losses, effectively lowering their overall tax liability. Below are three diverse, practical examples of tax-loss harvesting strategies that can be implemented by individual investors.
In a declining market, investors often find themselves holding stocks that have significantly decreased in value. By strategically selling these stocks, they can realize losses that can offset gains from other investments.
An investor, Jane, holds 100 shares of Company A, which she purchased at \(50 per share. The stock has now dropped to \)30 per share, leading to an unrealized loss of \(2,000. Meanwhile, Jane also has 50 shares of Company B, which she bought at \)40 per share and has risen to \(70, providing her with a \)1,500 gain.
To execute a tax-loss harvesting strategy, Jane sells her shares of Company A for \(30, realizing a \)2,000 loss. She can then use this loss to offset her \(1,500 gain from Company B, reducing her taxable income by \)500. Additionally, Jane can reinvest the proceeds from the sale of Company A into a similar stock (not identical, to avoid the wash sale rule), maintaining her market position while benefiting from tax savings.
Investors often have multiple accounts, including retirement accounts and taxable brokerage accounts. Tax-loss harvesting can be employed across these accounts for enhanced tax efficiency.
Mark has two brokerage accounts: a taxable account and an IRA. In his taxable account, he holds 200 shares of Company C, purchased at \(80 each, now trading at \)50, resulting in a \(6,000 loss. In his IRA, he has 100 shares of Company D, initially bought at \)30 each, which have climbed to \(60, providing a \)3,000 gain.
Mark sells his shares of Company C in the taxable account, realizing a \(6,000 loss. He can use this loss to offset the \)3,000 gain from Company D in the IRA, reducing his taxable income by $3,000. This approach not only provides immediate tax relief but may also help in managing future tax liabilities, as the losses can carry forward to future tax years.
Investors often hold a diversified portfolio across various asset classes. Tax-loss harvesting can be strategically applied to improve overall tax efficiency while maintaining diversification.
Samantha has a diversified portfolio that includes stocks, bonds, and ETFs. She holds shares of an ETF that tracks international markets, purchased for \(100 per share, now trading at \)70 per share, resulting in a \(3,000 unrealized loss on 100 shares. Meanwhile, she has other investments, including domestic stocks, that have appreciated and generated a \)4,000 capital gain.
Samantha decides to sell the international ETF to realize the \(3,000 loss. This loss can be used to offset \)3,000 of her capital gains from her domestic stocks, reducing her taxable income. To maintain her exposure to international markets, she immediately invests the proceeds into a different international ETF with similar characteristics, ensuring compliance with the wash sale rule.
By implementing these examples of tax-loss harvesting strategies, investors can effectively manage their tax liabilities while continuing to pursue their investment goals.