Tax Loss Harvesting Explained

Tax loss harvesting is a tax reduction trick designed to reduce the amount you pay to Uncle Sam. It can be used quite regularly and many investors use it to either postpone or to reduce what they have to pay altogether. Let’s take a look at what tax harvesting is.TaxLoss

The Principle

The principle of tax loss harvesting is to intentionally sell an investment when it’s in a losing position. This shows up as a loss on your balance sheet. Some investors will even do this the day before the financial year ends.

Even if you’ve had a profitable year, this will make the year seem much less profitable, or even make it show up as a bad year.

The Legality Issue

It’s certainly not in the spirit of the tax code, but there’s nothing wrong with it. An investor can sell their holdings at any time for any reason they see fit. You won’t be getting any ominous knocks on your door should you decide to employ this strategy.

Concrete Example

Let’s say an investor has a $10,000 holding. They may decide to sell this holding for $9,000 at a time where it would be advantageous for tax reasons. Now their accounts show a $1,000 loss. Capitals gains are charged based on profits, so the investor pays less tax.

Beware the Risks

It can go wrong if you don’t react in the right way afterwards. For example, you may want to repurchase the asset, but if someone else has jumped in ahead of you that loss on your balance sheet could turn into a long-term loss.

As you can see, employing tax loss harvesting successfully requires some forethought on your part.

Image credit: Alan Cleaver

About the author

Seattle CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Leave a Reply