Tax loss harvesting is an income tax planning strategy that involves selling investments at a loss with the intent to offset capital gain income. This strategy is beneficial to taxpayers who have large capital gain income and are seeking ways to lower their related income tax liability. It is important to note that any tax harvesting must be implemented prior to the end of the applicable tax year, which is December 31st for individual taxpayers.

Any capital losses harvested will be first used to offset any capital gain income. Short-term capital losses first offset short-term capital gain income, and then any remainder would offset long-term capital gain income. Long-term capital losses are the inverse; these losses first offset long-term capital gain income, and then any remainder offset short-term capital gain income.

In the case that total capital losses exceed total capital gain income for the current tax year, $3,000 can be used to offset a taxpayer’s ordinary income, such as wage income. Any remainder will then be carried forward to future tax years, where the same rules apply. All net capital losses carried forward to future years retain their character (short-term or long-term) and are again used in the ordering rules previously noted. Note there is no timeline for when the carryover needs to be used by. It will be carried forward indefinitely until fully utilized.

There are some considerations when it comes to harvesting tax losses. One rule to keep in mind is wash sale rules, which state that the taxpayer cannot buy the same or a “substantially identical” stock within 30 days before or after the sale, or else the loss is disallowed and added to basis. Another wrinkle is that some states do not follow Federal rules. For example, New Jersey does not allow any remaining net capital losses to be carried forward to future tax periods. Thus, any unused capital gain losses in the current year will be lost. In this case, it would be ideal to have coordinated tax capital losses harvested to equal the capital gains if possible. Tax loss harvesting can also be a great year-end planning strategy.

Authors: Kristyn Amato, CPA | [email protected] and Dan Krolikowski, CPA and Team Leader, Founders and Tech Executives | [email protected]

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