The season of selling is here
The final quarter of any given year marks the start of a lot of things. It’s most notably known for the holidays, but you’ve also got open enrollment, the start of a new fiscal year, seasonal depression, and of course tax-loss harvesting. Wait, which one of those doesn’t belong?
It’s historically been the most volatile time of year for the markets, making it a good time to cut some losses just before the 2021 tax year comes to a close. The season of selling may be a little dreary in some respects but provides a window of opportunity in others.
Losing money for a good cause
ICYMI: In the simplest of terms, tax-loss harvesting is the act of clearing out losing positions in your portfolio in an attempt to decrease your taxable capital gains.
Of course, Uncle Sam is watching though, and this tactic is no secret. Because of that, we have what’s known as the wash sale rule, which bars investors from selling an asset for a capital loss and then buying it (or a “substantially identical asset”) right back within 30 days.
Generally speaking, engaging in tax-loss harvesting is only worth it if it saves you more in taxes than your loss, or the investment with a negative return is just a lost cause.
🌰 Here's a visual from Schwab on how this all works in a nutshell, assuming you have two investments—one with a $20K capital gain and another with a $25K capital loss—and a tax rate of 35%:
Other implications & what this means for us
Now that you’ve got a high-level refresher on how to legally manipulate your tax bill, it’s worth noting that there are a few other benefits one can reap come harvest season this year.
- You might get some discounts: It’ll take a lot of scouting and knowing the right stocks, but if you can find a company you believe in that has a lot of bag holders at the moment, it might be a good candidate to drop by year’s end, giving you a better opportunity to buy-in.
- Using losses to reduce taxable income: Using this strategy can also be used to reduce your ordinary income if you’re in the red entirely and have no net capital gains for the year. You can deduct up to $3,000 of capital gains losses, and carry over any excess to next year’s tax return.
- Reevaluating your strategy: Taking losses on our investments can and should cause us to reflect. Tax-loss harvesting is a good consolation prize, but it won’t outweigh bad investing habits, so use this as an opportunity to assess the nature of your losses.
💡 Here's Finny's lesson on Tax Loss Harvesting if you want to learn more: