Selling Losing Securities For A Tax Advantage

Are you still holding on to that loser tech stock or mutual fund that you bought during the last bull market run? Or maybe you have a sentimental security that stopped making any significant appreciation since you purchased it. Well, from a tax standpoint, there might be no better time than the present to "dump that dog". The tax advantages of setting your gains against your losses can be enormous as long as you follow all the rules and implement a few tricks of the trade.

Tax-loss harvesting, also commonly known as tax selling, is one of the ways to avoid taxes on some of your portfolio gains. Tax-loss harvesting is the selling of securities, usually at year-end, to realize portfolio losses, which an investor can use to offset capital gains and therefore lower personal tax liability.

Tax Treatment of Gains

If you, like many others, own shares of a mutual fund, you are most likely subjected to some type of year-end payout. This could be in the form of a dividend, interest payout, short-term capital gain or long-term capital gain. Now, if the security giving you the payout is in a taxable account, then Uncle Sam will be sure to want a piece of the pie come tax time. For tax-reporting purposes, the short-term gains and losses (those made in one year or less) are first netted against each other for the tax year; then long-term gains and losses (those made in more than one year) are netted; and finally the remaining outcomes are combined together.

So, a net short-term loss of $10,000 can be applied against a net long-term gain of $5,000 for a remaining short-term loss of $5,000 [-$10,000 + $5000 = -$5000]. In any given year, there is no limit on the amount of capital losses that can offset capital gains. However, only a maximum of $3,000 net loss can be deducted from ordinary income; any excess loss may be carried forward into future tax years. The carry-forward loss must maintain its definition as either a short- or long-term loss.

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