Tax loss harvesting is a strategic technique used by investors to optimize their tax liability by offsetting capital gains with capital losses. This method involves selling investments that have decreased in value (capital losses) to counterbalance the taxes owed on capital gains, potentially leading to reduced overall tax payments.
Here’s how tax loss harvesting works and how it can help in maximizing tax efficiency:
1. Capital Gains and Losses: Capital gains are profits made from the sale of investments, while capital losses occur when the sale of investments results in a decrease in value compared to their purchase price.
2. Tax Offset: By selling assets that have experienced losses, investors can use those losses to offset capital gains from other investments. The losses effectively reduce the taxable income, thus lowering the amount of tax owed.
3. Tax Rate Consideration: Capital gains and losses are subject to specific tax rates, which can vary based on factors like holding period and the investor’s tax bracket. Offsetting gains with losses can help investors pay taxes at a lower rate.
4. Short-Term and Long-Term Capital Gains: Different tax rates apply to short-term (investments held for less than a year) and long-term (investments held for more than a year) capital gains. Careful planning can help investors choose the right assets to offset specific types of gains.