If you’ve had some losses in your investment portfolio, there’s a way to turn those losses into tax breaks. It’s called “tax-loss harvesting,” and it can help you save money on your taxes. Here’s how it works:
When you sell an investment at a loss, you can use that loss to offset any gains you’ve made from other investments. So, if you’ve made a profit in one area but lost money in another, the loss can reduce the amount of tax you owe on your gains. If your losses are greater than your gains, you can use up to $3,000 of those losses to reduce your regular income taxes each year. And if you have even more losses, you can carry them forward to offset future gains or income.
David Flores Wilson, a certified financial planner, says tax-loss harvesting is a great way to lower your tax bill, especially if you keep doing it throughout the year.
But there’s a catch: The “wash sale rule” could stop you from getting the tax break if you buy the same or a very similar asset within 30 days of selling it. This means you can’t sell a losing investment just to claim the loss and then buy it back right away. The IRS doesn’t allow that, and you’ll lose out on the tax break.
Here’s where exchange-traded funds (ETFs) can come to the rescue. Experts say ETFs can help you avoid the wash sale rule while still staying invested. The trick is that there are lots of ETFs that might hold similar stocks, but aren’t exactly the same. For example, you could swap out a losing large-cap value ETF with another one that focuses on the same type of stocks but in a slightly different way. Just make sure the ETFs aren’t too similar, like two that track the same index (like the S&P 500), because that could trigger the wash sale rule.
Since the IRS doesn’t have a clear-cut definition of what counts as “substantially identical,” it’s always a good idea to double-check your plans with a tax advisor to make sure you’re on the right track.
In short, tax-loss harvesting can be a great strategy to save on taxes, but be mindful of the rules. If you’re unsure about anything, it’s always good to ask a professional for guidance.
