Key Takeaways
- Sell investments at a loss to offset capital gains.
- Offsets up to $3,000 in ordinary income annually.
- Commonly done late in the calendar year.
- Wash-sale rule prevents repurchasing same asset immediately.
What is Tax Selling?
Tax selling, also known as tax-loss harvesting, is the strategic sale of securities or investments at a capital loss to offset capital gains realized elsewhere in your portfolio, reducing your overall income tax liability. This practice is commonly executed late in the calendar year to maximize tax benefits.
By leveraging tax rules that allow losses to offset gains, tax selling helps you manage your portfolio's tax efficiency while maintaining investment objectives.
Key Characteristics
Tax selling involves distinct features that impact your investment and tax planning:
- Capital Loss Realization: Selling assets below their adjusted cost basis to produce deductible losses.
- Offsetting Gains: Losses first offset gains of the same type, such as short-term against short-term.
- Income Reduction: Excess capital losses can reduce up to $3,000 of ordinary income annually, enhancing your ability to pay taxation.
- Carryforward Provision: Unused losses can be carried forward indefinitely to future tax years.
- Year-End Timing: Most tax selling occurs in December to meet annual tax deadlines.
How It Works
When you sell an asset, such as shares of BND or SPY, for more than your adjusted basis, you realize a capital gain. Selling below the basis results in a capital loss, which you can use to offset gains from other sales.
Tax losses first offset gains of the same holding period type, then can apply up to $3,000 against ordinary income each year. Remaining losses carry forward. To avoid disallowed deductions, be mindful of the wash-sale rule, which prevents claiming losses if you repurchase substantially identical securities within 30 days.
Examples and Use Cases
Tax selling is particularly useful in volatile markets or when rebalancing your portfolio:
- Index Funds: Selling losing positions in funds like IVV can offset gains from profitable sales elsewhere.
- Bond ETFs: Losses realized on BND can reduce taxable income while maintaining bond exposure.
- Equity ETFs: Harvesting losses in SPY is common among investors managing diversified U.S. equity portfolios.
Important Considerations
While tax selling offers clear benefits, it requires careful execution to avoid pitfalls such as wash sales and unintended portfolio drift. Tracking cost basis accurately through brokerage records is essential to ensure proper tax reporting.
You should also weigh tax savings against transaction costs and investment goals. Consulting a tax advisor can help tailor tax selling strategies to your specific situation and coordinate with retirement accounts like a backdoor Roth IRA.
Final Words
Tax selling can significantly reduce your tax liability by offsetting gains with losses, especially near year-end. Review your portfolio for potential loss positions and consider consulting a tax professional to optimize your strategy before the calendar closes.
Frequently Asked Questions
Tax selling, also known as tax-loss harvesting, is the strategic sale of investments at a loss to offset capital gains and reduce your overall tax liability, typically done near the end of the year.
By selling investments at a loss, you can offset capital gains from other sales, lowering the amount of taxable income. If losses exceed gains, up to $3,000 can offset ordinary income annually, with any leftover losses carried forward to future years.
Short-term losses first offset short-term gains, which are taxed at ordinary income rates, while long-term losses offset long-term gains, which benefit from lower tax rates. This matching helps maximize tax efficiency.
Yes, the wash-sale rule prevents you from claiming a loss if you repurchase the same or substantially identical security within 30 days before or after the sale. Also, sham transactions like selling to yourself are not allowed.
Tax selling is most common late in the calendar year, especially December, to meet tax deadlines and offset gains realized during the year. It often intensifies after market downturns when losses are more available.
Tax selling applies to stocks, bonds, and certain real estate investments, but losses on personal-use assets like cars are nondeductible. Collectibles and some real estate gains are taxed differently, so consider those rules.
If your capital losses exceed your capital gains, you can use up to $3,000 of those losses to reduce ordinary income each year, with any remaining losses carried forward indefinitely to offset future gains or income.
