Series 4: Tax Loss Harvesting and Carryover of Capital Losses

November 9, 2022

What if you lose money on your investments? A tax loss can be a valuable asset if you use a strategy called “tax loss harvesting,” which is based on the ability to offset capital gains with capital losses so that you only pay tax on your net capital gains. However, there’s a certain sequence you have to follow when offsetting gains with losses. First, short-term losses are used to offset short-term gains, and long-term losses are used to offset long-term gains. Then, if there are any losses remaining, they can be used to offset the opposite type of gain.

For example, let’s say this year you have the following gains and losses:

  • $80 long-term gain from selling A Corp. stock;
  • $10 long-term loss from selling B Corp. stock;
  • $20 short-term gain from selling C Corp. stock; and
  • $50 short-term loss from selling D Corp. stock.

You first offset your $50 short-term capital loss against your $20 short-term capital gain, resulting in a $30 net short-term loss. Then use your $10 long-term loss to offset your $80 long-term gain, resulting in a $70 net long-term gain. The $30 net short-term loss can then be applied against your $70 net long-term gain, resulting in an overall net long-term capital gain of $40.

What if you have an overall net capital loss? Up to $3,000 per year in capital losses ($1,500 if married filing separately) can be used to offset ordinary income (such as wages) in computing your tax liability. You can also carry forward any unused capital losses (i.e., above $3,000) to future tax years until they are used up. But, unfortunately, you can’t carry back your capital losses to prior tax years.

However, if you trade in and out of stocks in an effort to harvest tax losses, pay attention to the “wash sale” rule. This rule prevents you from harvesting a loss on securities you sold if you repurchase the same or substantially identical securities within 30 days before or after your sale. It also applies across your brokerage accounts, so if your investment advisor sells stock of a company at a loss in one of your accounts and you buy the same stock within 30 days in another account, your loss is still disallowed. For this reason, if you engaged in tax loss harvesting, you should consider purchasing a different replacement security.

Source: Kiplinger