Tax loss harvesting is a strategy to reduce an individual’s tax liability by offsetting taxable capital gains with capital losses. The Internal Revenue Code (IRC) allows individuals to deduct up to $3,000 in capital losses each year against their taxable income, which can be used to reduce the amount of tax owed. If the capital losses exceed $3,000, the excess can be carried forward to future tax years.
Tax loss harvesting involves selling investments that have decreased in value, resulting in a capital loss, and immediately or shortly after purchasing a similar investment. This allows the investor to realize the capital loss and use it to offset capital gains, reducing their tax liability.
It’s important to note that the IRC has strict rules regarding tax loss harvesting, including the wash sale rule, which prohibits the sale of an investment to realize a loss and then immediately repurchasing a substantially similar investment. Violating the wash sale rule can result in the disallowance of the loss for tax purposes.