Saving Want to Reduce Your Tax Bill? Let’s Talk About Tax-Loss Harvesting

Here’s how this strategy works, how it can help you save money and when you should consider implementing it.

By Adam Shell Illustration: Verónica Grech
PUBLISHED 01/20/2023 | 5 MINUTES

Sure, losses piling up in your investment portfolio is a downer. But, from a tax standpoint, there’s an upside to market downturns: You can trim your tax bill by selling your clunkers and using those losses to offset gains from winning investments.

This strategy is known as “tax-loss harvesting” or “tax-loss selling.”

“Investors can use tax-loss selling as a strategy to turn lemons into lemonade,” says Lauren Wybar, senior financial advisor at Vanguard Personal Advisor Services.

And who doesn’t want to trim their tax bill, especially in a year when portfolio account balances have shrunk?

“Losing positions have gotten more plentiful in many portfolios,” says Christine Benz, director of personal finance at investment research firm Morningstar. “Tax-loss selling is one of the few silver linings of a tough market environment.”

No kidding. If there was ever a good time to put this tax-smart strategy into action, it’s in 2022.
The S&P 500 has dropped nearly 25% in the first three quarters of 2022. And, in early October, 338 of the stocks in the S&P 500 stock index were down 10% or more. To make matters worse, normally stable bonds are deep in the red as well.

So let’s talk about what you can do.

How Tax-Loss Harvesting Works

First, you sell a stock or investment that’s faring poorly and trading for less than you bought it for. You then use those losses to offset your taxable capital gains and possibly some regular income too. This year, for example, you might be able to offset sizable losses in hard-hit tech stocks with gains in oil companies, which are up sharply this year due to higher gas prices.
You can offset your gains with losses, according to IRS rules.

If your capital losses exceed your gains, the IRS allows married couples who file joint returns to claim up to $3,000 of those losses to lower their taxable income. And if you have capital losses in excess of the IRS limit, you can carry over the loss up to $3,000 in any future tax year, indefinitely, until the amount is exhausted.

How It Can Reduce Your Tax Bill

There are two ways tax-loss harvesting can trim your taxes:

  1. The losses can be used to offset an unlimited amount of capital gains. (Note: Capital gain distributions from taxable mutual funds you own are viewed as gains by the IRS.) For example, let’s say you own two stocks. Stock A, which has increased in value, has a $10,000 capital gain. And Stock B, which has decreased in value, has a $10,000 capital loss. If both stocks were sold, there would be no tax liability on the gain from Stock A.
  2. If you don’t have any capital gains, or your losses are larger than your gains, your losses can also offset $3,000 of ordinary income on a joint return. Say you bought a stock for $10,000 and sold it when it was worth $7,000. If you have no other gains, you could use the $3,000 loss on the stock sale to reduce your taxable income for the current year. Or if Stock A has a capital gain of $10,000 and Stock B has a loss of $13,000, selling your losing stock will not only eliminate the capital gain on Stock A but will also offset $3,000 in ordinary income.

And remember, any remaining capital losses can be carried forward indefinitely.

When Tax-Loss Selling Makes Sense

Here are three ways to identify tax-loss selling candidates in your portfolio:

  1. The losing investment no longer fits into your long-term investment plan.
  2. The investment is unlikely to come roaring back due to poor prospects for future growth.
  3. The investment can easily be replaced by other investments that serve a similar role.

And there’s one other key benefit of selling a losing stock for tax purposes:

“Tax-loss selling lets you sell an investment at a loss and move your position into a similar—but not identical—investment,” says Wybar. “This allows an investor to remain in the market and benefit from the rise in the market when it recovers.”

Millie content is licensed from Dotdash Meredith, publisher of Millie, Real Simple, InStyle, Investopedia, The Balance and more.

Adam Shell is a freelance journalist who worked as a financial markets reporter at USA Today and an associate editor at Kiplinger’s Personal Finance magazine.

Illustration: Verónica Grech


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