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Loss harvesting is a strategy used by investors to reduce their tax liability by offsetting capital gains with investment losses. It involves selling investments that have declined in value to realize a loss, which can then be used to offset gains from other investments. This approach can help investors retain more of their profits and manage their tax obligations effectively.
Understanding Capital Gains and Losses
Capital gains occur when an investment is sold for more than its purchase price. Conversely, a capital loss happens when an investment is sold for less than its purchase price. Tax laws typically allow investors to offset gains with losses, reducing the amount of tax owed on profitable investments.
How Loss Harvesting Works
To implement loss harvesting, investors identify investments that have declined in value and sell them to realize a loss. These losses can then be used to offset capital gains realized elsewhere in the portfolio. If losses exceed gains, up to $3,000 of the excess loss can be deducted from ordinary income annually, with remaining losses carried forward to future years.
Best Practices for Loss Harvesting
- Review your portfolio regularly to identify potential losses.
- Be aware of the wash sale rule, which disallows claiming a loss if the same or a substantially identical security is repurchased within 30 days.
- Coordinate loss harvesting with your overall tax planning strategy.
- Consult with a tax professional to optimize benefits and ensure compliance.