What Is Tax Selling?

Tax Selling Explained in Less Than 5 Minutes

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Tax selling is the practice of selling losing assets to reduce capital gains taxes. Because you can offset your losses against your gains, tax selling can lower your overall tax bill. This means that even when an investment loses money, you may be able to use it to your advantage through tax selling.

To take advantage of this tax reduction strategy and minimize your capital gains taxes, we’ll cover some examples of tax selling, detail how it works, and discuss when it makes sense for you as an investor.

Definition and Examples of Tax Selling

When you sell an investment for a loss, you can use your losses to reduce your capital gains on profitable investments. Tax selling is a strategy that investors use to minimize their taxes by selling some stocks at a loss to offset capital gains.

  • Alternate names: Tax-loss harvesting, tax-loss selling

For example, suppose you sold Stock A for $10,000 more than you paid for it after holding that stock for a year. Let’s say you also sold Stock B more than a year after you purchased it, but at a $6,000 loss. Because of the tax selling rules, you’d only owe long-term capital gains taxes on $4,000 because you’d deduct your losses from your gains.

If, instead, you sold Stock A for a $10,000 loss and Stock B for a $6,000 profit, you’d have a $4,000 capital loss. You could deduct $3,000 of the loss from your income for the year. Then, you could use the remaining $1,000 to reduce a future year’s capital gains. Or you could carry forward the entire $4,000 loss for future tax years.

Use IRS Form 8949 with Schedule D to report capital gains and losses on most assets, including stocks, bonds, and real estate.

How Tax Selling Works

When you sell an asset, find the sale price and subtract the adjusted basis (the amount you paid for the asset plus a few additional costs). This will determine whether you have a capital gain or a capital loss. The amount you pay in capital gains taxes depends on how long you’ve held the asset as well as your taxable income.

If you sell an asset you’ve held for less than a year, it’s treated as a short-term capital gain or loss. Any profit made in short-term gains is taxed as regular income in ordinary income-brackets, which are as high as 37%. An asset you sell after holding for more than a year will result in a long-term capital gain or loss. Tax brackets for most long-term capital gains are taxed at 0%, 15%, or 20% based on your income.

Depending on your financial situation, you may be able to use your long-term capital losses to offset your long-term capital gains—and your short-term capital losses to offset your short-term capital gains. Then, you can use your long-term capital gains and losses to offset their short-term counterparts, or vice versa. If your capital losses are higher than your capital gains in a certain year, you can deduct a loss of up to $3,000, or $1,500 if you’re married and filing separately from your spouse.

You can also carry forward a capital loss and use it to reduce your taxable income in a future year.

What It Means for Individual Investors

You don’t have to worry about capital gains or tax selling for tax-advantaged accounts such as a 401(k) or an individual retirement account (IRA). That’s because you earn all capital gains, dividends, and interest tax-free until you withdraw the money. For traditional accounts, the money is taxed as ordinary income when you withdraw it. With Roth accounts, though, you generally won’t owe taxes because you’ve contributed post-tax money.

Tax selling may be most effective when you’re using short-term losses to offset short-term gains. Using short-term losses to offset long-term gains may not be a good strategy because your tax rate is lower on long-term gains. It may be a better tactic to use short-term losses to offset regular income or carry them forward to another year. Discuss your options with a financial adviser to make the right decision for your situation.

If you’re using tax selling, it’s important to be aware of the IRS rules that prohibit wash sales. A wash sale occurs when you sell an investment at a loss and then buy the same investment or one that is “substantially identical” to it 30 days before or after the trade. If the IRS considers the transaction a wash sale, you won’t be allowed to use it to lower your taxes.

Key Takeaways

  • The tax selling process occurs when investors sell assets at a loss to offset capital gains, thereby reducing their income tax liability in a given year.
  • Tax selling makes the most sense when you’re offsetting short-term losses against short-term gains. This is because short-term capital gains are usually taxed at a higher rate than long-term capital gains.
  • A wash sale occurs when you sell an investment at a loss and then purchase the same or “substantially identical” investment within 30 days before or after selling. Wash sales are precluded from tax deductions.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.