Harvest losses to maximize your tax savings
What to look for?
When looking for tax-loss selling candidates, consider investments that no longer fit your strategy, have poor prospects for future growth, or can be easily replaced by other investments that fill a similar role in your portfolio.
When you're looking for tax losses, focusing on short-term losses provides the greatest benefit because they are first used to offset short-term gains—and short-term gains are taxed at a higher marginal rate.
According to the tax code, short- and long-term losses must be used first to offset gains of the same type. But if your losses of one type exceed your gains of the same type, then you can apply the excess to the other type. For example, if you were to sell a long-term investment at a $15,000 loss but had only $5,000 in long-term gains for the year, you could apply the remaining $10,000 excess to any short-term gains.
What to avoid?
If you have harvested short-term losses but have only unrealized long-term gains, you may want to consider saving them for the future. The least effective use of harvested short-term losses would be to apply them to long-term capital gains. But, depending on the circumstances, that may still be preferable to paying the long-term capital gains tax.
Also, keep in mind that realizing a capital loss can be effective even if you didn't realize capital gains this year, thanks to the capital loss tax deduction and carryover provisions. The tax code allows you to apply up to $3,000 a year in capital losses to reduce ordinary income, which is taxed at the same rate as short-term capital gains.
If you still have capital losses after applying them first to capital gains and then to ordinary income, you can carry them forward for use in future years.
In next blogpost, we will discuss wash sale and tax loss harvesting.