3 Tips to Get Started on Tax-Loss Harvesting

As tax season approaches, many investors are tallying up the capital gains that they have accumulated and realized during the year. But there is still time to improve those final numbers and reduce the amount of taxable gains that must be reported if you have one or more losing holdings in your portfolio. There is a silver lining that can be generated from harvesting tax losses in your taxable retail portfolios before the end of the year. Just use the following three tips to reduce your taxable gains.

Go through your retail portfolio and see which holdings have lost value since you purchased them. Don’t bother doing this in your retirement accounts, because you can’t declare any losses that you have there since they are tax-advantaged accounts. If you have purchased a losing holding in your taxable portfolio that has declined in value within the past year, then you can sell it to generate a short-term loss. If you have held your losing holding for more than a year to the day, then it will be considered a long-term loss when you sell it. This applies regardless of whether the holding is a stock, bond, mutual fund or exchange-traded fund (ETF). In fact, it theoretically applies to just about any type of investment, even if it’s not publicly-traded, although selling certain types of investments, such as real property may obviously not be feasible for this strategy. (For more, see: A Complete Guide to Tax Loss Harvesting with ETFs.)

The Internal Revenue Service (IRS) puts a lid on how investors can sell losing holdings in their taxable accounts in order to generate capital losses. In order to declare a loss, the investor cannot buy back the same security or another security that is considered to be materially identical to the one sold within 31 calendar days of the sale. So if you sell ABC company stock on November 15, then you cannot declare the loss if you buy back those shares before December 17. This does create the risk that the price of the security may go up during the waiting period. But the waiting period can extend into the following year. If you sell a stock or other security in December, then you can still declare the loss on your taxes for that year as long as you wait at least 31 days before buying it back.

If you think that there is a good chance that the price will soon rise in the security you just sold, then you may be wise to simply use the proceeds from your sale to buy something different. Consider using the proceeds to buy an ETF that invests in the sector of your previous holding. This can provide you with additional diversification and you won’t need to wait for 31 days to buy it. This is not always the right thing to do. In some cases that losing holding may constitute a vital portion of your portfolio, and you may believe that it will recover at some point. If so, then you are probably wise to just wait out the holding period and then buy the security back. You may also get lucky and be able to get in at an even lower price after 31 days. (For more, see: How Tax-Loss Harvesting Can Save You Money.)

If you have substantial capital gains to declare for the year and also have some losing holdings in your portfolio that you would like to hold on to, then harvesting them for capital losses can reduce your tax bill. This strategy can even allow you to net long-term losses against short-term gains if your long-term losses exceed your long-term gains depending upon the amount of gains and losses that you have. For more information on tax-loss harvesting, read the instructions for Schedule D of the 1040 or consult your tax or financial advisor. (For more, see: Pros and Cons of Annual Tax-Loss Harvesting.)