What is Tax Loss Harvesting?

Tax loss harvesting is a financial strategy designed to offset taxes that would apply to capital gains earned during the tax period. The strategy usually focuses on gains created by short-term investments, since many countries tax capital gains on these types of investments at a slightly higher rate than gains earned by long-term investments. While tax loss harvesting is a workable and legal strategy in many nations, there are usually some limitations on how the harvesting approach can be utilized.

In order to create the tax loss, it is necessary to sell a short-term security at a loss, effectively creating a capital loss on that investment. The capital losses that are experienced by the sale help to offset the capital gains earned on a different short-term investment. This tax loss harvesting strategy will only work if the capital gains and the capital losses take place within the same taxation period.

While the tax loss harvest does help to minimize taxes, the process does also reduce the amount of overall gains for the period. As one way to minimize the loss, many investors will choose to purchase stock that is connected with a company still within the same general category, but not like the stock that was sold. For example, if the stock sold was connected with a long distance service provider, the investor may choose to replace the stock by purchasing shares in a conference call bureau. Both companies are considered part of the telecommunications industry but are not similar in their nature and function.

In the event that the investor wants to repurchase shares of the stock that was sold in order to create the tax loss harvesting, it is important to observe applicable laws that govern this action. Often, there is a waiting period before the repurchase can take place and not impact the tax loss harvesting process. In just about every situation, it is necessary to wait at least a full calendar month before initiating the repurchase.

Investors should keep in mind that many countries do not impose limits on the amount of capital losses that may be claimed against capital gains earned in the tax period. However, there are usually some limits on how much of the loss incurred as part of the tax loss harvesting can be applied to ordinary income. The death of a spouse during the tax period may also impact how the loss created with the harvesting strategy can be applied to the gains earned during the period. In order to understand exactly how tax loss harvesting can function within a given country, it is important to become familiar with all regulations that affect trading activity within that country.