Many investors have unrecognized tax losses in their portfolios. Unrecognized losses occur when a security held in a portfolio has declined in value and has not been sold. Those losses are recognized for tax purposes (i.e., made deductible) when the security is sold. Still, there are rules in the Internal Revenue Code that limit the deduction of those losses. Those rules provide for the deferral of loss recognition while at the same time accelerating gain recognition.
For example, one rule allows only a $3,000 net capital loss deduction per year to offset ordinary income, such as income from wages or self-employment. There is also a “wash sale” rule that disallows the deduction of capital losses from the sale of a security if you buy a substantially identical security within 30 calendar days before or after the sale. These rules put up roadblocks for deducting capital losses, but the roadblocks can be avoided by the strategy of tax loss harvesting.
The simple strategy is to sell securities with enough capital gains to directly offset capital losses. This is a straightforward way to get around the $3,000 loss limitation in any given tax year.
With respect to the wash sale rules, if the sale of a security generates a loss, but the investor would still like to own the security, they can purchase the same security outside the 30-day window. Alternatively, an investor can avoid the wash sale rules if they purchase a different security with similar prospects as the loss security even if the purchase is within the 30-day window. An example of this would be to sell shares of an oil company at a loss but buy shares of another oil company with similar prospects.
Tax loss harvesting can be engaged in throughout the year but is a popular strategy at year-end when investors are estimating their tax liabilities for the entire year. Fulcrum Wealth Advisors can assist its clients with these tax planning strategies.
For further discussion, see https://www.forbes.com/sites/forbesbusinesscouncil/2022/01/18/underrated-way-to-save-on-business-tax-tax-loss-harvesting-explained/