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Sunday, July 14, 2013

How to tax-loss harvest share sales

Tax-loss harvest share sales can be used to lower tax brackets
Capital losses lower taxable income
Active investors seeking to preserve capital gains and minimize capital losses benefit from utilizing tax-planning techniques such as tax-loss harvesting. This is a trading technique used specifically to capture losses for the purpose of offsetting taxes on profits gained from the sale of financial products such as corporate shares. According to Vol. 88:229 of the Washington University Law Review, in effect, tax-loss harvesting converts a capital loss into a tax deduction thereby recouping some or all of the lost value from capital loss via prudent use of the tax regulations.


Loss harvesting works by bundling stock purchases into separate transactions and then claiming a loss from one sale against the profit from another. For example, by purchasing 100 shares of Company A in May and another 100 shares in June, an investor can sell the shares that yield no profit for a capital-loss. Since capital-losses are used to offset income and capital gains for tax purposes, this method creates more financial advantage when used than when left underutilized.


Title 26 of the U.S. code also known as the tax code. Section 1091 of this code does place some limitations on loss harvesting however. More specifically, what is commonly known as the “wash-sale rule” prevents investors from selling and re-purchasing stock within a 30-day period of they are to qualify for capital losses. According to Charles Schwab and Co., Inc, the wash sale rule also applies to the exchange of exchange traded funds and mutual funds.


The use of loss harvesting must be implemented before the tax filing deadline in order for it to apply to that year's reported taxable income. However, since capital gains taxes decline for positions held for over a year, and the ability of tax filers to use capital-loss carryover, the tax-loss harvesting technique is also used on a multi-year basis. Capital losses can still be deducted without harvesting losses.


Proper use of tax-loss harvesting allows investors to lower their financial risk as the technique serves as loss mitigation. In other words, because the capital-losses are being recovered via re-investment and tax deduction, the net effect of investing in risky assets is lowered. This method can therefore be used as an alternative to other investment strategies such as selling covered calls in option trading.


There is no guarantee the second investment in the loss-harvesting process will appreciate in value. Moreover, this method does not necessarily increase return on investment. There is also a limit to the amount of capital losses that can be harvested, and the process itself takes careful attention to timing, and active participation in investment re-allocation per the Wall Street Journal.

Investing involves risk, but there are ways to reduce the consequences of such risk. Loss-harvesting for tax benefits is one such method. However, since managing finances often involves more than one detail, investment product or technique for carrying out broader financial goals, the effective use of loss-harvesting may be overlooked or passed over due to lack of time or attention required of active investing. 

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