Nobody likes investment losses – however, they are a reality that investors must occasionally face when investing. The objective of tax-loss harvesting is simply to use any unrealized losses that have been incurred to improve the overall tax position of the investor. This might seem a little counter-intuitive – in that I am suggesting that a LOSS can help improve an investor’s overall tax situation. However, consider this – if an investor has an existing tax liability and an unrealized loss on some investments – why not use that loss to offset some of that tax liability? The mechanism for accomplishing this is to realize the losses that are presently only unrealized. Some might call this making a paper loss an actual loss.
Selling positions in a taxable brokerage account that show an unrealized loss converts that loss to a realized loss, and thus, creates a tax event. This tax event of realizing the loss is what allows the account holder to capture a potential tax deduction on their income taxes. These capital losses can help offset capital gains from the sale of other assets made throughout the year. If the account holder doesn’t have any capital gains to offset, they may be able to deduct up to $3,000 of realized capital losses against ordinary income each tax year until the loss is used up1.
There remains the question of what can then be done with the proceeds from the sale of the investment that was made to convert the unrealized loss on the investment to a realized loss. This is where it is very important to understand the IRS rules regarding wash-sales. The proceeds from selling the investment to realize the loss may be used to purchase a different investment immediately, or the same investment – after waiting for 30 days – to prevent running afoul of the wash-sale rule2. Confirm these rules with your tax advisor and seek their input for your specific situation.
The material discussed in this article is for informational purposes only. Neither Covenant Wealth Advisors nor its Investment Advisory Representatives may give legal or tax advice. Readers are strongly encouraged to obtain professional advice specific to their own situation.