Just about everybody can recite the one central tenet of investing: buy low and sell high. But tax-loss harvesting is one of the few opportunities for you to actually do better by selling low
See, tax-loss harvesting is a method for saving on taxes by unloading investments that have lost money. If, for example, a $100,000 investment loses 10% of its value in a year, by selling it, the IRS will recognize that you realized a $10,000 loss. This $10,000 loss will be used to either offset your taxable income or even help you get a fat refund at year’s end.
But since you sold the investment you won’t realize any of those super cool gains once it recovers, right? Wrong. Tax loss harvesting involves two steps — selling the beleaguered asset, but also immediately turning around and purchasing another one that’s nearly identical. In this way, it’s a totally legal, legit way of outfoxing the tax code. On paper, you’ll look like the chump who lost big on a bad bet — and who gets to benefit at tax time for it. But in fact you’ll still be in the game, waiting for your other similar investment to turn around.
Another great aspect of tax-loss harvesting? It provides you a trump card you don’t necessarily need to play right away, or you can put towards past tax years. Any losses can be applied to the last three years’ taxes or forward indefinitely.
But be warned: to avoid the wrath of the authorities that might suspect you’re trying to cheat the government out of taxes, the investment you repurchase can be very similar, but not materially identical to the one you dropped.