Minimize Taxes on Investments – Tax Loss Harvesting

When do you pay taxes on your investment accounts?  Well…. it depends.  : )

For retirement accounts, like a 401k or IRA, you pay taxes on the money when you take money out of the account, i.e. a “distribution”.  And, you pay ordinary income tax rates on the amount you take out.  This rate is most likely higher than the normal capital gains rate.  For NON-retirement accounts, like a individual brokerage account, you pay taxes when you sell the investment for a gain.  Note the difference here.  It’s not WHEN you take the money out of the account like in an IRA, the taxable event would be created at the time of sale even if the money stays in the account.

But, what if you have a loss on the investment?  We know you have to pay a “capital gains tax” on all gains, but what about any losses?  Well, you are allowed to REDUCE any gains with any losses you may have from other investments.  This is called “tax loss harvesting”.  If you sell an investment for a gain, in order to lower your tax liability, you can look for other investments in your account to sell for a loss.  This helps minimize your taxes owed on your investment accounts.

But what if you really like the stock that had a loss because you think it has great long term potential?  You can buy it back but make sure you wait 30 days.  This is to avoid the “wash sale rule”.  This is a rule the IRS put in place to put limits on tax avoidance.  If you bought the stock back before the 30 day limit, the loss could be disallowed for tax purposes.  So in summary, tax loss harvesting can be an effective tool to lower your tax liability on your investments, but make sure you are strategic and follow the rules.