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If you’re an investor in things like cryptocurrency (crypto), real estate, or securities, it can be a great way to put your money to work for you and potentially increase your net worth and income. Yet, it’s essential to understand it can come with the risk of investment loss.
If your portfolio takes a beating during the tax year, there is some good news. There are tax strategies to buffer a loss or reduce what you owe the Internal Revenue Service (IRS). It’s called tax loss harvesting. Follow along as we outline the details of harvestable tax losses and how to offset capital gains for investors.
What is tax loss harvesting?
Essentially tax loss harvesting is when you purposefully sell assets at a loss. In turn, the losses from those investments’ gains let you offset your gains elsewhere in your investment portfolio and if you have enough losses, reduce your ordinary income, and in turn, potentially your tax bill.
Tax loss harvesting opportunity
As an investor, it’s important to note that tax loss harvesting only applies when you actually sell or exchange your securities or crypto at a loss. (Related read: Learn more about cost basis.) The same applies to any gains you’ve received from transactions. You can’t offset capital gains with losses if the gains and losses are only on paper (meaning you didn’t have a transaction or actually realize a gain or loss).
A quick review on capital gains and losses
A tax loss harvesting strategy is commonly used to reduce the amount of taxes owed on short-term capital gains, which are taxed higher than long-term capital gains. As a quick review, let’s revisit a few terms.
First, a capital asset is any asset you (an investor) own, whether physical or intangible:
- Tangible examples include jewelry, gold, and precious metals; however, losses from personal use assets aren’t deductible (Read more about the capital gains on a home sale).
- Intangible examples include patents, trademarks, and intellectual property
- Financial assets such as cryptocurrency, stocks, bonds, and other securities
Second, capital gains and losses are generally the difference between what you paid for an asset (your basis) and what you sold it for.
- You’ll have a capital gain if you sell an asset for more than you bought it.
- You’ll have a capital loss if you sell an asset for less than you bought it.
You adjust your basis (increase or decrease) by certain costs. For example, you increase the basis of stocks by any commission you paid to purchase the stock.
Third, capital gains are taxed based on the length of time you own the asset.
- Short-term capital gains apply to assets you’ve held for a year or less.
- Long-term capital gains apply to assets you’ve held for more than a year.
Learn more about how to calculate capital gain taxes as a tax and investment strategy.
How to offset capital gains with losses: What to know
You can offset capital losses against your capital gains to reduce your total taxable income (gain). Once you’ve identified the right assets for tax loss harvesting and you sell them, the next step is offsetting capital gains with losses.
Tax loss harvesting rules and limitations
To make sure you’re going about it the right way and avoid a tax liability, it’s a good idea to be aware of the investor rules around offsetting capital gains for your tax bill.
- You can’t tax loss harvest with individual retirement accounts because you can’t deduct the loss from a tax-deferred account.
- IRS wash sale rules prevent you from selling and then purchasing essentially identical stock for the sole purpose of creating a deductible loss. If you have a loss on a wash sale, you won’t be able to deduct it from your taxes based on the current rules. However, the disallowed loss on a wash sale is added to your basis in the new stock or securities purchased.
- Capital gains and losses must be grouped together by time frame—i.e., short- or long-term. We’ll cover harvestable loss more in the next section.
Harvestable tax loss: Why short-term and long-term holdings matter
It can get confusing when you have a lot of capital gains and losses that include both long-term and short-term assets. Long-term gains have a lower tax rate than short-term gains. To offset either type of gains, you’ll have to group like with like. This is sometimes called “netting capital gains and losses”.
Here is an overview of the basic rules:
- Long-term capital gains − long-term capital losses = net long-term capital gains
- Short-term capital losses − short-term capital gains = net short-term capital losses
- Net long-term capital gains – net short-term capital losses = net capital gains
- Losses that exceed gains may offset ordinary income up to $3,000 ($1,500 Married Filing Separately) per year. Any excess is carried forward to the following year.
Tax loss harvest in action
Here’s an opportunity to better understand how tax loss harvesting works with this helpful example:
Sebastian is an amateur investor who has owned cryptocurrency for three years. This year, he sold his shares—some at an income gain and some at a loss. Let’s work through the math to see how Sebastian was able to offset his capital gains and reduce his ordinary income with the remaining losses.
| 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 and losses, he had $1,000 in capital losses left over.
He can use the $1,000 in capital loss to reduce his ordinary income.
Learn more about crypto taxes.
Get help with reporting harvesting losses
In most cases, you’ll use Form 8949 to report your investor gains and losses on Schedule D.
If you need help reporting harvestable tax losses or need guidance on how to increase your tax breaks, let H&R Block help so you lower your tax liability and maximize income. Make an appointment with one of our tax pros today who can help with investment gains, tax efficiency, and capital gains tax. Or, if you prefer to file on your own, our online tax filing product can help you.
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