Tax loss harvesting is an investment strategy that involves selling losing investments to offset the capital gains realized from selling winning investments. By doing this, investors can reduce their tax liability and potentially increase their after-tax returns.
The basic idea behind tax loss harvesting is that when an investment has declined in value, the investor can sell the investment to realize a capital loss. This capital loss can then be used to offset capital gains realized from other investments sold during the same tax year. If the capital loss is greater than the capital gains, the investor can use the excess loss to offset up to $3,000 of ordinary income for that tax year. Any remaining capital losses can be carried forward to future tax years.
It's important to note that tax loss harvesting must be done carefully to avoid violating the wash-sale rule, which prohibits an investor from buying the same or substantially identical investment within 30 days before or after the sale that generated the capital loss. If the wash-sale rule is violated, the capital loss is disallowed and the investor's tax strategy could be compromised.
Overall, tax loss harvesting is a valuable tool for investors who want to minimize their tax liability while maintaining a diversified investment portfolio.