I’m sure there’s something crucial I’m not understanding, but it seems like you’re just losing money? I’m trying to learn about investing and I’m so confused
In: 11
If you sell a stock for profit, you owe taxes on the profit.
However, if you sell a stock for a loss, you can offset that with the profits.
So if you have a stock you are negative in and you don’t think it will recover (or at least not by a worthwhile amount in a worthwhile time), you can sell it and then when you sell another stock for profit, and you can minimize (or even eliminate) taxes owed.
EDIT: You can buy back the the stock/fund you sold after about a month, so you kind of reset where your starting point is at (and usually the prices haven’t changed a ton in a month,) and you lowered the taxes you’ll owe on profits from others stocks/funds.
Yes, you’re losing money…. think of it as a consolation prize if you have a loser investment, that if you sell and realize that loss you can at least reduce your taxable gains elsewhere, and thus reduce your taxes a bit. You don’t go looking to sell at a loss, but say you bought Bed, Bath & Beyond stock and it’s never going to go back up, you might choose when to sell based on if it’ll help reduce capital gains taxes on other investments.
Tax-loss harvesting is a way to offload taxes from now to later. If you sell at a loss in this year, the government will take that out of any investment profits you made this year before taxing it, so you get a small break. This tax loss can be carried forward year over year, if it’s larger than your investment profits. At the same time, you can simply reinvest into the same fund later this year; your investment position hasn’t significantly changed, but you have an investment loss on the books. This is counterweighed by the fact that your new investment holdings have a lower purchase value, so will have greater “profit” when you end up selling them again.
The value in this is that a dollar saved today and invested today is worth a lot more than a dollar saved and invested X years later. So having “losses” now means less money paid out to taxes this year, which means more money put into investments earlier. Yes, you will pay more in taxes later, but the additional investments you’ve made in the mean time from the taxes you’ve saved should yield more money than the additional taxes you’re paying.
It feels like losing money because it is. Tax deductions, whether it’s from capital losses or your mortgage interest, are really trading dollars for quarters (or dimes + nickels, half dollars, whatever your tax bracket might be).
Say you donate $10k to charity. You can deduct that expense from your taxes. What most people think that means is you owe $10k less on your taxes. What it actually means is that the government has agreed to not tax that $10k. So this deduction isn’t saving $10k, it’s saving you taxes on $10k, which is about $2,500 if the income is in a 25% tax bracket.
Tax-loss harvesting is a bit more complex, but essentially the same. If you sell stock at a $10k loss, you can avoid paying taxes on a $10k gain somewhere else. But make no mistake about it, you’re still losing $10k and only getting a fraction of that back in tax savings.
If you are eligible for a tax deduction, you absolutely should take it. But you will lose money if your goal is to create tax deductions.
Two rules are in play: you can deduct losses if you sell a stock for less than you bought it for, but you aren’t allowed to deduct it if you buy it back soon after (wash sale rule).
The most effective tax loss harvesting I’ve seen is when you’re long on an asset: say, S&P 500 index fund. It has ups and downs like anything else.
You can sell shares, at a loss, when they dip below what you paid for them, and immediately buy a closely related but not identical stock (say, a Large Industrials index fund). That will likely follow the same general pattern as what you were in before. When the wash sale period is over, you can sell that stock and get back into what you were in, originally.
That way, you’ve “harvested” the loss to use to reduce your income taxes, without taking much risk in missing a big market upswing in the meantime, and you’ve avoided the wash sale rule that would prevent you from deducting that loss.
Let’s say you brought stock in Company X for $100, but now it’s only worth $50. You don’t think it is going to go down any further, but you also don’t think it is going back up anytime soon. Eventually, you’ll want to sell it so you can invest the remaining $50 in something better.
Assume you like the rest of your investments besides Company X and don’t want to sell any of the others this year. If you sold shares of Company X this year, you would simply be taking a loss. Instead, you hold on to it to ‘harvest’ later.
Fast forward a year. You have a stock in Company Y that you also bought for $100. It did really well and is now worth $200. After doing your research, you don’t feel it will go much higher, so you decide to sell. Since it went up $100, you would have to pay taxes on this money. You can now also sell your shares of Company X for $50. You can deduct the $50 you lost from the $100 you gained and only have to pay taxes on $50 of profit.
Someone with a lot of wealth is going to have a lot of different investments in a lot of different things. Even the best investors will have investments that don’t pan out. The idea is to pair your gains with some of these inevitable losses.
Latest Answers