In a non-retirement account, tax-loss harvesting is the process of intentionally selling investments that have lost value. There are a variety of reasons it may be a strategy worth considering. For example, it could help you:

1. Pay less in taxes by reducing your overall income by up to $3,000 per year
2. Offset the taxes owed from selling other investments at a profit
3. Reduce your income and/or tax liabilities in future years (losses greater than $3,000 per year carry forward)
4. Rebalance your portfolio and/or adjust your asset allocation

By paying less to Uncle Sam today, you can keep more of your hard-earned money working for you in the market rather than putting it toward taxes. And by selling weaker-performing investments, you may be able to improve your portfolio’s overall returns in the long term.

Tax-loss harvesting is a strategy you can use whether the market is up or down. However, it’s especially beneficial following a market correction (a decline of 10% or more from a peak high) or a sharp decline in a particular holding. 

What You Need to Know
Your portfolio’s value fluctuates often, both up and down. But those changes aren’t locked in until you sell an asset, or “realize” the difference. Selling an investment at a profit is considered a realized capital gain; selling it for less than the purchase price is considered a realized capital loss.

Each year, the IRS allows you to weigh out capital gains and losses and deduct up to $3,000 in net capital losses to reduce your income or offset realized gains on your tax return. If your losses exceed $3,000, you can carry the additional amount forward indefinitely.

If you’re selling a holding but want to replace it with another that serves a similar purpose, be careful to avoid a wash sale (replacing what you sell with another holding that’s too similar within 30 days). If you violate the wash-sale rule, the capital loss is no longer considered tax deductible (see “Wash Sale Dos and Don’ts").

Things to Keep in Mind

To successfully harvest losses for tax purposes, you’ll need to know how long you’ve held an asset and the price at which you originally purchased it (its cost basis).

If you’ve held an asset for more than a year, it’s considered a long-term holding; less than a year is considered a short-term holding. 

The IRS treats long-term investing more favorably: Long-term capital gains are taxed at 0%, 15%, or 20% depending on your income level. Short-term capital gains are taxed at the same rate as your regular income, from 10%-37% using 2021 tax brackets. 

There are many ways to determine cost basis, from “first in, first out” to average cost. Frankly, it can get a little tricky. It’s best to work with your financial or tax professional to review records and make sure you know where things stand before selling investments for tax-loss harvesting purposes.

Tax-Loss Harvesting: A Benefit for Both Boom and Bust Years

Remember, tax-loss harvesting can help whether your portfolio is in a boom or bust year. Even in a down year without many gains to offset, it could still make sense to harvest your losses to reduce your overall income this year. Any additional losses can be used in future years, too. Think of it as a tax-deduction piggy bank: You can store this year’s losses to offset another year’s gains down the road.