Investors naturally love a banner year. Maybe they realized long-term capital gains on a super stock or day traded themselves into a small fortune. Either way, big wins make for a happy New Year.
Then the tax bill arrives. Long-term capital gains (investments held for over one year) taxes range from 0% to 20%, depending on your tax bracket. The IRS taxes short-term capital gains (assets held for less than one year) at normal tax rates, which range from 10% to 37%.
The tax bite reduces returns for all investors, regardless of their tax bracket, and the tax loss harvesting strategy provides a dollar-for-dollar reduction in the bite.
The savings can be tremendous. For a top-bracket taxpayer, a $50,000 long-term capital gain and a $50,000 short-term capital gain results in a tax bill of $28,500. That is a 28.5% reduction in investment proceeds.
Most of us would rue the day when we had to dig $28,500 out of our brokerage- or bank accounts to pay Uncle Sam on earnings we bore substantial risks in attaining. Besides, we probably have some investments with some unrealized losses.
Shouldn’t we get a tax deduction for the decline in value of those assets?
You can with tax loss harvesting. At the same time, if you believe losing assets will turn around, you can remain invested in similar assets that will rebound the same way in the coming months or years.
What Is Tax Loss Harvesting?
Tax loss harvesting is a strategy that allows investors to take tax deductions against winning investments after their profits are realized. Since the investor likely has some investments that have unrealized losses, it makes tax sense for the investor to sell them to offset some of the gains and reduce the tax bite.
But what if the investor believes the assets with unrealized losses will rebound and become profitable?
In that case, the investor rebuys a similar security that he or she expects to rebound in the same way. For example, investor A may be showing an unrealized loss on an artificial intelligence (AI) exchange traded fund (ETF) near then end of the tax year.
AI ETFs invest in a large number of AI related stocks.
Investor A can harvest the loss on the ETF to reduce capital gains tax. Since many other AI ETFs exist, the investor can then purchase a different AI ETF, gaining the tax deduction while remaining invested in AI.
Tax loss harvesting is like having your cake and eating it to.
How Tax Loss Harvesting Works
To employ a tax loss harvesting strategy, advanced tax planning is required. To offset gains, the realized losses must occur during the same tax year. Therefore, if you have capital gains in 2021, you must sell any losing securities on or before December 31, 2021 to use the tax deduction. Once Tax Day rolls around, it is too late.
For example, Investor A analyses his brokerage account in late 2021 and calculates he will have a tax bill of $28,500. To cover this, he will need to draw down his bank account and sell some securities. If he can reduce the tax bite, he will be able to keep more money invested in the market, allowing him or her to make more money in the future.
Investor A sees that he or she has a $10,000 unrealized loss in an AI ETF. He or she believes that the loss in the AI ETF is temporary and that the investment will rebound and become highly profitable in the future.
To harvest the tax loss, he or she sells the ETF before the end of the year, reducing the tax bite dollar-for-dollar, from $28,500 to $18,500. Investor A then buys a similar AI ETF, so that he or she can still benefit from the anticipated price increase in AI ETFs.
Tax Avenger CPAs Slash Your Capital Gains Taxes
Tax loss harvesting is just one method of reducing capital gains taxes. Tax Avenger CPAs are experts in reducing capital gains taxes, whether through deductions or qualifying you for a lower tax bracket. Our CPAs analyze investment accounts to maximize tax saving opportunities. In addition, they sift through your entire financial situation to discover the best possible tax scenario and set the strategies that make it reality.
If you need to reduce your tax bill, contact Tax Avenger Canton MI today. We are dedicated to providing exceptional service to our clients. Our services include business accounting and payroll services, individual and business tax preparation, tax problem resolutions and more. You work hard for your money. Let us help you keep it.