What is Tax-loss Harvesting and How to Use It

Tax-loss harvesting is an investment strategy that aims to maximize after-tax returns by offsetting capital gains with capital losses. Here are some key things to know about tax-loss harvesting: Here is an example of how tax-loss harvesting can benefit an investor. Let’s say John has a portfolio valued at $100,000 as of December 31st. Within the portfolio: – Stock A was purchased for $10,000 and is now worth $8,000, resulting in a $2,000 loss. – Stock B was purchased for $20,000 and is now worth $25,000, resulting in a $5,000 gain. – Stock C was purchased for $30,000 and is now worth $30,000, neither a gain nor loss. – Stock D was purchased for $40,000 and is now worth $42,000, resulting in a $2,000 gain. Without tax-loss harvesting, John would owe tax on the $7,000 total capital gains ($5,000 + $2,000). However, through tax-loss harvesting, John sells Stock A at a $2,000 loss and purchases a similar replacement investment. This $2,000 loss offsets the $2,000 gain from Stock D, reducing the total gains to $5,000. As a result, John lowers his total capital gains tax obligation. This leaves more money compounding over time in his investment portfolio. So tax-loss harvesting provides an opportunity to reduce taxes and increase long-term investment returns because it’s a way to maximize after-tax profits by using investment losses to directly reduce taxes owed on capital gains.