If you sell an investment for a loss, you can use your losses to reduce your capital gains on profitable investments. Tax selling is a strategy that investors use to minimize their taxes by selling some stocks at a loss to offset capital gains. It is also referred to as tax-loss harvesting or tax-loss selling. Any profit made in short-term gains is taxed as regular income in ordinary income-brackets, which are as high as 37%. An asset you sell after holding for more than a year will result in a long-term capital gain or loss. Tax brackets for most long-term capital gains are taxed at 0%, 15%, or 20% based on your income. Depending on your financial situation, you may be able to use your long-term capital losses to offset your long-term capital gains—and your short-term capital losses to offset your short-term capital gains. Then, you can use your long-term capital gains and losses to offset their short-term counterparts, or vice versa. If your capital losses are higher than your capital gains in a certain year, you can deduct a loss of up to $3,000, or $1,500 if you’re married and filing separately from your spouse.
Example of Tax Selling
For example, suppose you sold Stock A for $10,000 more than you paid for it after holding that stock for a year. Let’s say you also sold Stock B more than a year after you purchased it, but at a $6,000 loss. Because of the tax selling rules, you’d only owe long-term capital gains taxes on $4,000 because you’d deduct your losses from your gains. If, instead, you sold Stock A for a $10,000 loss and Stock B for a $6,000 profit, you’d have a $4,000 capital loss. You could deduct $3,000 of the loss from your income for the year. Then, you could use the remaining $1,000 to reduce a future year’s capital gains. Or you could carry forward the entire $4,000 loss for future tax years.
What It Means for Individual Investors
You don’t have to worry about capital gains or tax selling for tax-advantaged accounts such as a 401(k) or an individual retirement account (IRA). That’s because you earn all capital gains, dividends, and interest tax-free until you withdraw the money. For traditional accounts, the money is taxed as ordinary income when you withdraw it. With Roth accounts, though, you generally won’t owe taxes because you’ve contributed post-tax money. Tax selling may be most effective when you’re using short-term losses to offset short-term gains. Using short-term losses to offset long-term gains may not be a good strategy because your tax rate is lower on long-term gains. It may be a better tactic to use short-term losses to offset regular income or carry them forward to another year. Discuss your options with a financial adviser to make the right decision for your situation. If you’re using tax selling, it’s important to be aware of the IRS rules that prohibit wash sales. A wash sale occurs when you sell an investment at a loss and then buy the same investment or one that is “substantially identical” to it 30 days before or after the trade. If the IRS considers the transaction a wash sale, you won’t be allowed to use it to lower your taxes.
