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Tax-Loss Harvesting: the What, Why, and How Thumbnail

Tax-Loss Harvesting: the What, Why, and How

Good tax preparation should start well before your taxes are due. If you want to save the most money possible, it’s crucial to work with a financial advisor you trust who can help you implement every tax reduction strategy at your disposal. There’s one strategy in particular that can cut your tax bill next year that not all investors are aware of — and that’s tax-loss harvesting.

If you’re wondering what tax-loss harvesting is, why it might be a good strategy for you, and how you can take advantage of it, we’ve got you covered.

What is tax-loss harvesting?

Tax-loss harvesting is “the timely selling of securities at a loss to offset the amount of capital gains tax owed from selling profitable assets.”1 In other words, it’s a simple way for investors to make lemonade out of lemons during a significant stock/bond market correction.

At Encompass, we help clients look under the hood of their investment portfolio to find unrealized losses. We then sell the losing position to get the loss on the books, or “realize” it. This loss can be used to offset capital gains realized within the same calendar year. After offsetting gains, if there are left over losses, they can be used to potentially offset up to $3,000 of ordinary income. Additional unused losses can be carried over into a later tax year.

Why might tax-loss harvesting be right for me?

If you’re an investor with significant unrealized capital loss in your taxable brokerage account (Individual, Joint, Trust, etc.), then tox-loss harvesting can be a great strategy for cutting your tax bill. This is especially true for investors who:

  • Expect a capital gains tax liability in the current year.
  • Anticipate a large capital gains tax liability in the future (i.e. selling a business, selling real estate, or owning stock in a company that’s planning an IPO or other liquidity event).
  • Own mutual funds that regularly pay out capital gains distributions.
  • Want to diversify out of a concentrated investment with large unrealized capital gains.

Whatever your particular situation might be, tax-loss harvesting can help you offset future tax liability. Federally, capital gains can be taxed up to 20% plus an additional 3.8% for individuals with income above $200,000 ($250,000 for married filing jointly). Many states also tax capital gains at varying rates. By offsetting these gains with realized losses through tax-loss harvesting, you send less money to Uncle Sam and keep more money in your account.

How can I take advantage of tax-loss harvesting?

At Encompass, our advisors take clients through a straightforward and thorough process to help them get the most out of their tax-loss harvesting strategy. This includes:

  1. Evaluating and estimating a client’s current and expected capital gains liability.
  2. Reviewing taxable investment portfolios for unrealized losses.
  3. Determining which securities would make sense to sell.
  4. Selling the losing security to realize the loss.
  5. Considering alternative investment options for the sale proceeds.

In many instances, we will immediately reinvest the sale proceeds in a different security that meets a client’s needs and long-term investment objectives. This allows them to reap the tax benefits from the sale without significantly altering their overall investment exposure.

We also work to help our clients avoid triggering a “wash sale.” According to the wash-sale rule, “if an investment is sold at a loss and then repurchased within 30 days, the initial loss cannot be claimed for tax purposes.”2 Essentially, the wash-sale rule prevents investors from creating an investment loss for the benefit of a tax deduction while more or less maintaining their position in the security. If the transaction is deemed a wash sale, the capital loss is disallowed and will be added to the cost basis of the substantially identical security that was purchased.

Let Encompass save you money this year with tax-loss harvesting.

If you’re thinking about how you can save money on your taxes, reach out to connect with an Encompass advisor today! We’d love to talk you through tax-loss harvesting and all the other strategies we can help implement to bring your tax bill down next year.