How Tax-Loss Harvesting Helps to Lower Your Tax Bill

An older man concentrates as he looks over paperwork and uses a calculator. — (Image credit: Getty Images)

Tax season is here, and many investors are looking at their capital gains and losses in 2023 to determine what they will owe in taxes. Not all of your investments can be winners. But through a tax strategy known as tax-loss harvesting, your losses may be able to help you lower your tax bill.

Tax-loss harvesting is generally considered an end-of-year planning strategy. However, there are opportunities throughout the year to thoughtfully manage your gains and losses in order to plan for your year-end tax bill. Work with your financial adviser to continually review your portfolios and consult your accountant to understand if tax-loss harvesting is appropriate for your situation and you can fully benefit from it.

If you would like to consider tax-loss harvesting, here are a few things to keep in mind.

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Tax-loss harvesting basics

When you sell a security at a price higher than you paid for it, you realize a capital gain. Generally, realized gains will be subject to capital gains taxes. Tax-loss harvesting is a strategy to sell securities that have a loss (that is, their current price is less than you paid for them) and use those losses to offset gains on other investments. If done properly, tax-loss harvesting can effectively reduce or eliminate the capital gains tax incurred on realized gains in the same tax year.

In addition, if you have more realized capital losses than realized capital gains in a tax year, you can use up to $3,000 of unused losses to offset ordinary income. You can then carry forward any remaining unused losses to use against future capital gains.

The wash sale rule

Many investors may look to take advantage of unrealized losses in securities they would still like to own. However, if you would like to take advantage of a tax-loss harvesting strategy, you must be careful to not trigger a wash sale, which could disallow your loss in the year it is realized.

A wash sale occurs when you sell an investment at a loss and then purchase the same investment or one that’s “substantially identical” within 30 days before or 30 days after the sale date, excluding the sale date. For example, if you are selling a stock at a loss and then purchase the same stock, a call option of the same stock or a security that is similar enough to the stock you sold, you can trigger a wash sale.

If a wash sale occurs, taxpayers will be prohibited from claiming a loss on the sale in the year it’s realized. Instead, the loss is deferred until you sell the replacement security. You should consult with a qualified tax professional to help determine whether a replacement security may be “substantially identical” to the one you sold.

How to avoid triggering a wash sale

If you’re planning to take advantage of a tax-loss harvesting strategy, it’s very important to be mindful of the 61-day window for triggering a wash sale as you make your investment decisions. For example, if you sell a stock at a loss on January 1, you would have needed to purchase that stock or any substantially identical security before December 2 (of the prior year) or after January 31 to avoid a wash sale.

Purchasing the same or substantially identical security in a different account, for example an IRA, is still a wash sale. If you have multiple accounts, including professionally managed accounts, it’s especially important to keep the wash sale rule in mind. If you sell a security at a loss in one account and your money manager purchases that security in a separate account within the 61-day period, it would trigger a wash sale.

There are a couple approaches that can keep you exposed to the market without triggering a wash sale:

You can “double up” on the security more than 30 days before you intend to sell it (and keep the newly purchased portion)
You can wait at least 30 days after you sell a security before you repurchase it
You could purchase a substitute security for a company in the same sector that may trade similarly, but is not deemed to be substantially identical by the IRS. For example, if you sell one beverage company stock at a loss and buy a different beverage company stock to replace it, this would not be a wash sale as long as the companies are not otherwise linked
You could sell a stock and then purchase a mutual fund or ETF that covers that stock’s sector, and it would not be a wash sale, even if the stock is owned by the fund

Ultimately, you should consult with your tax advisers to determine whether you are at risk for triggering a wash sale and undoing any tax-loss harvesting plans you have in place.

The views, opinions, estimates and strategies expressed herein constitutes the author's judgment based on current market conditions and are subject to change without notice, and may differ from those expressed by other areas of J.P. Morgan. This information in no way constitutes J.P. Morgan Research and should not be treated as such. You should carefully consider your needs and objectives before making any decisions. For additional guidance on how this information should be applied to your situation, you should consult your advisor.

JPMorgan Chase & Co., its affiliates, and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transaction.

J.P. Morgan Wealth Management is a business of JPMorgan Chase & Co., which offers investment products and services through J.P. Morgan Securities LLC (JPMS), a registered broker-dealer and investment adviser, member FINRA and SIPC.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Adam leads J.P. Morgan Wealth Management's Wealth Planning and Advice team, which is responsible for wealth planning, thought leadership and strategic planning for individual clients. This national team of former practicing lawyers provides experience in estate and tax planning strategies, retirement planning, restricted and control stock and stock option management, business succession planning, pre- and post-transactional planning, concentrated position management and other personal planning strategies. The team provides internal training to the J.P. Morgan Wealth Management sales force on these topics and also creates content for distribution to the public.