Investing in assets like cryptocurrency, real estate, or stocks can be a strategic way to grow wealth, but it also carries risks. If your investments have taken a hit this tax year, there’s a silver lining: tax loss harvesting. This tax-saving strategy allows you to offset gains with losses, potentially lowering your taxable income. Here’s a closer look at how it works and how you can take advantage of it.

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What is Tax Loss Harvesting?

Tax loss harvesting is the process of intentionally selling investments at a loss to reduce taxable gains elsewhere in your portfolio. By offsetting gains with losses, you can potentially lower your tax bill for the year.

When Does Tax Loss Harvesting Apply?

To benefit from tax loss harvesting, you must realize a loss by actually selling assets at a lower value than your purchase price. Unrealized losses, or those that remain “on paper” without a sale, don’t qualify for tax offsets.

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Quick Review of Capital Gains and Losses

Understanding a few basics about capital gains and losses is key to maximizing tax loss harvesting:

1. Capital Assets: Any item of value you own, whether tangible (e.g., jewelry or gold) or intangible (e.g., patents or stocks), qualifies as a capital asset. Personal-use asset losses, however, are not deductible.
2. Capital Gains and Losses:
   • Capital Gains occur when you sell an asset for more than you paid.
   • Capital Losses arise when you sell an asset for less than you paid.
   • Your basis in an asset can be adjusted by factors like purchase commissions.
3. Short- vs. Long-Term Capital Gains:
   • Short-term: Assets held for a year or less, taxed at a higher rate.
   • Long-term: Assets held longer than a year, taxed at a lower rate.

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Offsetting Capital Gains with Losses

To lower your taxable income, capital losses can be used to offset capital gains. Once you sell assets for tax loss harvesting, you’ll need to group and apply these losses by type (short- or long-term) to reduce your taxable gains.

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Important Rules and Limitations

To ensure compliance with IRS rules, here are key guidelines to consider:

• No Deduction for Retirement Accounts: Tax loss harvesting doesn’t apply to IRAs or other tax-deferred accounts.
• Wash Sale Rule: This rule prevents you from selling an asset at a loss and then buying a similar one within 30 days just to claim a deductible loss. Any loss from a wash sale is added to the basis of the new asset, affecting future gains or losses.
• Grouping Gains and Losses: The IRS requires short- and long-term gains and losses to be grouped separately to calculate net capital gains or losses.

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Why Asset Holding Periods Matter

Tax rates differ for short- and long-term gains, so you’ll need to group your capital gains and losses accordingly. This process is known as “netting.” Here’s how it works:

1. Net Long-Term Capital Gains = Long-Term Gains – Long-Term Losses
2. Net Short-Term Capital Losses = Short-Term Losses – Short-Term Gains
3. Net Capital Gains = Net Long-Term Gains – Net Short-Term Losses

If losses exceed gains, they can be applied against ordinary income (up to $3,000 per year for most taxpayers, $1,500 if married and filing separately), with any remaining losses carried forward to future tax years.

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Example of Tax Loss Harvesting in Action

Let’s say Sebastian, an investor, sold some of his crypto holdings at both a gain and a loss. Using tax loss harvesting, he could apply his losses to offset his gains, potentially reducing his taxable income further with any remaining losses. Let’s go through the calculations to see how Sebastian used his losses to offset his capital gains and applied the remaining amount to lower his ordinary income.

	Bitcoin	Dogecoin
Purchase price (Both assets purchased more than a year ago)	$10,000	$5,000
Sale price	$13,000	$1,000
Capital Gain/Capital Loss results And short/long breakout	$3,000 Long-term gain	-$4,000 Long-term loss

 

$3,000 gain – $4,000 loss = -$1,000

After offsetting his long-term capital gains with losses, he was left with a $1,000 capital loss. This remaining $1,000 can be applied to reduce his ordinary income.

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Need Help with Tax Loss Harvesting?

In most cases, you’ll report capital gains and losses on Form 8949, which you’ll then summarize on Schedule D. If you’re looking for guidance on reporting these transactions or maximizing your tax breaks, PSA CPA can help. Reach out to us at 301-879-0600 or contact@psacpa.com to schedule an appointment and lower your tax liability.