What Is Tax-Loss Harvesting? A CPA Explains.Personal Taxes
Tax-loss harvesting is a tax-reduction strategy that involves selling stocks at a loss in your portfolio to offset current- and future-year capital gains in your portfolio.
Tax-Loss Harvesting Example
For example, let’s say that you purchase 10,000 shares of two different individual stocks — Stock A and Stock B — for the price of one dollar per share in a taxable brokerage account.
So you’ve invested $10,000 in Stock A and $10,000 in Stock B.
Let’s say the value of your investment in Stock A rises to $20,000, but the value of your investment in Stock B drops to $4,000.
You believe that your portfolio is at this point overallocated to Stock A, so you sell off half of your position in Stock A for a capital gain of $5,000.
At the same time, you believe that Stock B is a bad investment overall and that you want to cut your losses.
So you sell your entire position in Stock B for a capital loss of $6,000.
Assuming these transactions are the only two capital transactions you engaged in during the year, your $6,000 capital loss on the sale of Stock B would first be netted against your $5,000 capital gain on the sale of Stock A.
This means that you would not be subject to any capital gains tax during the year.
You could then deduct the remaining $1,000 loss in Stock B against your ordinary income for the year.
If you are in, say, the 22% tax bracket, and you held Stock A for a year or less, your “harvesting” of your loss in Stock B could result in a $1,320 reduction in your federal tax liability for the year with additional potential tax savings at the state income tax level.
Is Tax-Loss Harvesting Right For You?
Given that the tax savings that tax-loss harvesting could generate are quite real, it can certainly be a good idea in some circumstances
But like most tax strategies, it’s not appropriate for everyone.
Here are some questions to ask yourself when determining if tax-loss harvesting is right for you:
1. Consider the wash-sale rules.
Within the last 30 days, did you purchase the investment you intend on tax loss harvesting?
Or do you intend to repurchase the investment within 30 days of selling it for a loss?
Answering “yes” to either of these questions could mean that you are prevented from taking a tax loss on the sale of the investment, thus negating any tax-loss harvesting benefit you were planning on taking.
2. Consider your long-term capital gains tax rate.
Before capital losses are applied — up to $3,000 — against your ordinary income, they are first applied against your capital gains during the year.
And gains on capital assets, like those in your investment portfolio, that are held for longer than one year qualify for long-term capital gain treatment for tax purposes.
Instead of being taxed at a taxpayer’s normal income tax rates, they are taxed at special 0%, 15%, and 20% rates based on the taxpayer’s taxable income (including all capital gains themselves).
These rates for 2022 are shown in the table below.
|Tax Filing Status||0% Rate||15% Rate||20% Rate|
|Single||$0 - $41,675||$41,676 - $459,750||$459,751+|
|Married Filing Jointly||$0 - $83,350||$83,351 - $517,200||$517,201+|
|Married Filing Separately||$0 - $41,675||$41,676 - $258,600||$258,601+|
|Head of Household||$0 - $55,800||$55,801 - $488,500||$488,501+|
So let’s say in 2022 your filing status is married filing jointly, and your only sources of income for the year are your $50,000-per-year job, your spouse’s $40,000-per-year job, and $15,000 in long-term capital gains.
Assuming you don’t have any adjustments to your income and you and your spouse take the standard deduction, your taxable income would be $79,100, calculated as follows
$50,000 Spouse A Wages
$40,000 Spouse B Wages
$15,000 Long-Term Capital Gains
– $25,900 Standard Deduction
$79,100 Taxable Income
In this case, since your taxable income falls in the taxable income range of $0 – $83,350 for the 0% long-term capital gains rate for the married filing jointly filing status, you would owe absolutely no federal taxes on your $15,000 long-term capital gains.
Nevertheless, any capital losses that you recognize during the year via tax-loss harvesting will still be applied against this $15,000 in long-term capital gains — but they will not generate any tax benefit because your gains are already in the 0% long-term capital gains tax bracket.
Note that while you still may benefit from the tax-loss harvesting for state income tax purposes, it may be better to “save” these losses — if they still exist — for when you will enjoy a federal benefit for them as well.
3. Consider your overall investment strategy.
One should rarely “let the tax tail wag the dog,” so to speak; always consider your tax strategies in light of your overall financial picture.
If selling your currently “losing” stocks at a loss doesn’t really fit well into your big-picture investment strategy, perhaps you should consult with a qualified financial advisor before making any rash moves.
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.