What is Tax Loss Harvesting And Why Do You Need to Do it?

We’ve all sat there looking at a losing trade wondering what we should do. After all, we don’t want to take a loss. However, there is a smart way that you can turn that investment loss into a win. It’s called tax-loss harvesting. Here’s how you can make the most of it.

What is Tax Loss Harvesting?

Tax-loss harvesting is a strategy where you sell your position in a losing trade for the purpose of writing off the losses on your taxes. Currently, tax rules allow you to write off $3,000 in tax losses per year. While $3,000 a year may not seem like a lot, you can roll any excess losses into the next tax year.

How to Sell Your Losing Investment and Still Stay In That Trade

One really smart strategy allows you to write off taxes and still technically stay in your trade. This is done by selling your position for a loss than then opening a position in a similar trade. For instance, let’s say that you sell your position in the Invesco Nasdaq Trust ETF (QQQ) for a loss. You can then purchase shares in the Technology Select Sector SPDR Fund (XLK) which has a 0.96 correlation with QQQ. That means that QQQ and XLK move in the same direction 96% of the time. Another popular ETF, SPRD S&P 500 ETF Trust (SPY) has a .996 correlation with the Vanguard Total Stock Market ETF (VTI).

Tax Loss Harvesting Allows You To Roll Excess Losses Into Later Tax Years

One of the great advantages of tax-loss harvesting is the ability to roll your excess losses into the next tax year. For instance, let’s say that you sell a position that results in an $8,000 loss. You can write off $3,000 in year one, $3,000 in year two, and $2,000 in year three of your tax filings.

Taking Advantage of Tax Loss Harvesting

When it comes to wealth planning, you not only have to think about growing your accounts, you also have to consider how to protect yourself from losses. With tax-loss harvesting, you can take a loss without actually losing all of your money in that trade. Best of all, you can take a similar trade to take advantage of any recovery. Be sure to talk to a wealth manager about how to best utilize tax-loss harvesting today.