Depending on how preemptive you are when it comes to investing, you may or may not be familiar with the term tax-loss harvesting. If your only form of future investment is a retirement account contribution then tax-loss won’t be of any help to you. However, if you own some kind of taxable investment then tax-loss harvesting may reduce your tax charges and also possibly economize on your money.
What is Tax-loss Harvesting
Tax-loss harvesting is referred to the method of utilizing the losses from your investment in order to reduce taxes on your capital gains. In simpler words, it represents that while you were able to make some profit off of your investments, you also suffered losses from others. Thus, you will not be indebted as much in tax charges.
The tax-loss harvesting procedure involves selling assets at a loss and purchasing similar investments. This enables you to benefit from losses for the purpose of taxes and also maintain your anticipated asset allocation.
If you are questioning why you need to sell an asset to realize the loss, consider this: when you purchase a brand new car, its value takes a plunge the second you drive it out of the showroom, but you do not suffer the loss nor do you see its effect on your wallet up until you decide to sell the car. Likewise, you may not be aware that your investments are underperforming; however, you cannot claim what you have lost until you sell your assets.
Who Should Benefit From Tax-Loss Harvesting?
Tax-loss harvesting is an ideal means for anyone who experiences capital losses and gains. Nevertheless, long-standing investors tend to save the most amount of money by utilizing this tactic.
If you hold your investments for extended periods of time, you will accumulate more savings. In addition, if you try to hold your assets for more than 12 months, then those will be taxed at a much lower rate automatically. Cutting your tax obligation can increase your net worth with time.
When Should Tax-Loss Harvesting Be Implemented?
Investors typically yield their investment losses at the year’s end, but one can do that any time. The reason why waiting until the year’s end could prove to be beneficial is if you wish to utilize your losses to balance what you have collected during the year. But if you decide to sell your losses at the start of the year, you may have an opportunity to rebuy some of your assets sometime later (potentially for a lower price) when others are selling their safekeepings.
It is important to remember that tax-loss harvesting is a technique to lower your tax liability. When you utilize your losses to decrease your taxes on capital income and gains, you ultimately save money. However, it is important to consider the wash sale rule.
The rule of wash sale forbids you from cutting losses when selling and then purchasing significantly similar securities within a span of a month pre and post-sale. A good way to evade this rule is by investing your money in exchange-traded funds. If you avoid switching from one exchange-traded fund to another that trails a similar index, the rule will not apply to you.