Tax Loss Harvesting

Tax loss harvesting can help you reduce your capital gains tax bill

Strategy Overview

Tax loss harvesting involves having a strong understanding of your capital gains/losses, so that you can strategically opt to sell certain assets to optimize your capital gains taxes. Recognized capital losses can be used to offset capital gains dollar-for-dollar for tax purposes. By realizing capital losses in the same tax year that you sell appreciated stock (having capital gains), you can net the losses against the gains to reduce your overall capital gains tax liability.

Tax Details

The equity an individual has (from exercised or vested stock-based compensation) can have significant capital gains when a company does well. In the year you sell and recognize gains, if you also have other investments with losses, tax-loss-harvesting gives you the ability to reduce your tax bill (by strategically selling losing stocks, generating capital losses to help offset the capital gains from your company stock). But like most tax strategies, its important to understand the rules. With tax-loss-harvesting:

1. All short-term capital gains and losses net against each other

2. All long-term capital gains and losses net against each other

3. Only after (1) and (2) have been netted, then you can net the remaining balances against one another

Important tax-loss-harvesting rules to know

• Make sure you don't have a "wash sale". The wash sale rule basically says that you cannot repurchase the same shares you sold for a loss within 30 days. If you do, the loss is invalidated (and instead the repurchased shares get a modified cost basis).

• No limit on losses. There is no limit to the amount of losses you can realize/use to offset gains.

• If losses > gains, you can use some to offset income and carry forward the rest. If your realized capital losses in a year are larger than your gains, two things happen:

  • (1) The first $3,000 in net losses can be used to offset your ordinary income each year.

  • (2) If net losses exceed $3,000, the additional amount is carried forward to future tax years, where it can (i) be used to offset future capital gains, and/or (ii) be used to offset $3,000 or ordinary income each year.

Key Benefits

• Ability to reduce your capital gains tax bill.

• If realized losses are greater than gains, it can help offset ordinary income (up to $3,000 per year), and any excess above that is carried forward to future tax years for use.

Key Considerations/Flags

• Must ensure you do not have a wash sale

• Losses must occur in the same year as realized gains, or in a future year (if losses were carried forward) in order to offset gains. Losses cannot be retroactively applied to prior year gains.

Strategy: When to Consider This and When to Avoid It

🟢 When to Consider This Strategy:

• You had significant capital gains this year and you have other investments with capital losses

🔴 When to Not Use This Strategy:

• You are currently in a low-income tax bracket and expect to stay in the lower brackets in future years (the tax savings may not be significant, or even non existent).

• The declines in the value of your taxable investments are relatively small or temporary dips. Realizing these small losses may not be worth it.

• The wash sale rule prevents you from claiming tax losses on investments you repurchase within 30 days before or after the sale date.

🟡 Consider on a Case By Case Basis:

• If you anticipate a change in your income tax bracket in future years. Capital gains tax brackets change/scale with income. If you anticipate a bracket change, you should consider what tax reduction would be achieved by recognizing losses this year versus in future years.

Example

Tax Loss Harvesting Example