Maximizing Returns, Minimizing Taxes: The Power of Tax Loss Harvesting
by Brad Acker
As an investor, it's crucial to know how to make the most of your returns while keeping your taxes to a minimum. One strategy that can assist you in achieving this is tax loss harvesting. But it's not a one-size-fits-all solution, and that's why I'm writing to you today.
Tax loss harvesting is a technique that can only be employed in taxable accounts, not in tax-advantaged accounts such as traditional and Roth IRAs or 401(k)s.
The reason being that in these tax-advantaged accounts, your investment gains and losses are not taxed until you withdraw them, rendering tax loss harvesting useless.
I have a taxable brokerage account with Robinhood but I also have a tax-advantaged (IRA and Roth IRA) account with Fidelity
Furthermore, tax-advantaged accounts have different rules and restrictions that make tax loss harvesting ineffective. For instance, traditional IRA doesn't allow you to deduct losses and Roth IRA doesn't permit you to withdraw your contributions before 59.5 years of age, otherwise you'll be penalized.
Despite this, there are alternative methods to manage taxes in tax-advantaged accounts, such as Roth conversions and recharacterizations, which you should consider when planning for your retirement savings.
When you invest in stocks or other securities, there may be times when the value of those investments decreases, referred to as a "capital loss." If you sell the investment at a loss, you can use that loss to offset any capital gains you may have from other investments. This is known as tax loss harvesting.
Let me give you an example.
If you bought a stock for $1,000, and it's now worth $500, if you sell it, you'll have a $500 capital loss. If you also have a capital gain of $500 from another investment, the two will cancel each other out, and you won't owe any taxes on your gains.
It's essential to note that you can only offset your capital gains and not your ordinary income, and also, you need to wait 30 days to repurchase the same stock after selling it to avoid the wash-sale rule.
On the other hand, taxable brokerage accounts are investment accounts that are subject to taxes. Unlike a tax-advantaged account like an IRA or 401(k), you'll have to pay taxes on any gains or dividends you earn in a taxable brokerage account. However, since you have more control over when you sell your investments, you can take advantage of tax loss harvesting opportunities to minimize your tax bill.
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In summary, tax loss harvesting is a strategy that allows you to offset your capital gains by selling investments that have decreased in value, and taxable brokerage accounts are investment accounts that are subject to taxes, but you can use tax loss harvesting opportunities to minimize your tax bill.
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Please note that this post is for informational purposes only and should not be considered as tax or financial advice. It is important to consult with a qualified tax professional or financial advisor before making any investment decisions or implementing any tax strategies.