Tax loss harvesting is a tax-advantaged strategy available to investors. It applies to securities and other assets. Basically, tax loss harvesting offsets gains with losses. But can it be applied to an IRA?
What Is Tax Loss Harvesting?
Tax loss harvesting sells losing positions and uses the loss to offset capital gains in a portfolio. The result is a reduction in taxable gains. These are losses and gains within the same year, not spread over multiple years.
For example, a portfolio has $5,000 in realized gains. Using simple math, at a 24% tax bracket, that’s $1,200 in taxes. There are also $2,500 in unrealized losses. By selling the losing positions and realizing a loss, the total gain is reduced to $2,500, cutting the taxable gain in half.
In the above example, $500 more in losses can still be applied from other income sources. This is due to the standard $3,000 loss limit. If more than $3,000 in losses are realized, the excess losses can be rolled into the next year.
One caveat of tax loss harvesting is that it must avoid the wash sale rule. This only applies to investors who want to sell an asset at a loss and buy it back in a few days. The wash sale rule states that an investor must wait 30 days to buy back the same or similar security. However, the investor can purchase a different security before 30 days.
Also, note that by waiting 30 days, the stock may rise. In that case, you’ll be buying it back at a higher price.
For investors with lots of positions, tax loss harvesting can be tedious. Most brokerages now automate tax loss harvesting. Tax loss harvesting does apply across all investor accounts. For investors with multiple investment accounts, there isn’t an easy way to tax loss harvest across all accounts since each brokerage is specific to assets within the account held at that brokerage.
Tax Loss Harvesting and IRAs
Now to the main question — can you tax loss harvest in an IRA? Unfortunately, the simple answer is no. Tax-deferred retirement accounts such as 401(k)s and IRAs don’t incur taxes on gains or dividends each year, which is necessary for tax loss harvesting. Instead, taxes are paid once distributions begin.
A Roth IRA is in a similar situation and is not eligible for tax loss harvesting. Roth IRA contributions are put in as after-tax funds and gains grow in the account tax-free, so there is no benefit to tax loss harvesting.
While most brokerages can automate tax loss harvesting, for those investors with several accounts at different brokerages, working with a tax advisor can help keep track of possible tax loss harvesting transactions. Additionally, a tax advisor can help in determining which assets or accounts qualify for tax loss harvesting.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
FAQs
Tax Loss Harvesting and IRAs
Can you do tax-loss harvesting in an IRA account? ›
As with any tax-related topic, there are rules and limitations: Tax-loss harvesting isn't useful in retirement accounts, such as a 401(k) or an IRA, because you can't deduct the losses generated in a tax-deferred account. There are restrictions on using specific types of losses to offset certain gains.
Can you claim losses in an IRA? ›
The Internal Revenue Service does not permit you to deduct losses from your Roth IRA on a year-to-year basis, so the only way to deduct your losses is to close your Roth IRA accounts.
Is there a limit to how much you can tax-loss harvest? ›
There is no limit to the number of losses that can be harvested. However, in any single tax year, losses are limited to the dollar amount of the gains recognized plus an additional $3,000 to offset ordinary income. Losses exceeding $3,000 can be carried forward and used to offset future capital gains.
Is tax-loss harvesting even worth it? ›
There are immediate benefits of tax-loss harvesting, such as lowering your tax bill for the year. However, more important are the medium- to long-term payoffs that you can get if you invest the money you freed up in something better. If you do decide to sell, deploy the proceeds thoughtfully.
What to do if your IRA is losing money? ›
The key, however, is to stay cool when that happens and not rush to sell off investments in that account when they're down. If you do that, you'll lock in your losses. If you sit tight, you can give your IRA a chance to recover, which it's likely to do.
Why are capital losses limited to $3,000? ›
The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.
How much will an IRA reduce my taxes? ›
Under age 50 you may deduct up to $6,500. Over age 50 you may deduct up to $7,500.
Is money in an IRA tax-deductible? ›
Your traditional IRA contributions may be tax-deductible. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels.
How much of my IRA contribution is tax-deductible? ›
Tax Deductibility of IRA Contributions (Tax Year 2023)
| Modified Adjusted Gross Income (MAGI) | Allowable Deduction |
|---|
| $73,000 or less | A full deduction up to the lesser of $6,500 ($7,500 if you're 50 or older) of your taxable compensation |
| Between $73,000 and $83,000 | A partial deduction based on your MAGI |
| $83,000 or more | No deduction |
Since many investors and financial advisors perform their tax-loss harvesting activity once a year, at the end of the year, let's look at the effectiveness of this strategy. The U.S. stock market, based on the S&P 500 Index, has ended the year positive more than 70% of the time since 1926.
Can capital losses offset IRA distributions? ›
Yes, within limits. If you sell stock at a loss, this "capital loss" is first netted against any capital gains. Then a max of $3000 of the remaining loss will carry to line 13 of the 1040 as a negative number and offset ordinary income.
What is the wash-sale rule for tax-loss harvesting? ›
The wash-sale rule prevents taxpayers from deducting paper losses without significantly changing their market position. Tax-loss harvesting is the deliberate selling of positions held at a loss to take advantage of the tax benefits of realizing losses.
Does tax-loss harvesting apply to IRA? ›
Now to the main question — can you tax loss harvest in an IRA? Unfortunately, the simple answer is no. Tax-deferred retirement accounts such as 401(k)s and IRAs don't incur taxes on gains or dividends each year, which is necessary for tax loss harvesting. Instead, taxes are paid once distributions begin.
How many years can you carry forward a tax-loss? ›
In general, you can carry capital losses forward indefinitely, either until you use them all up or until they run out. Carryovers of capital losses have no time limit, so you can use them to offset capital gains or as a deduction against ordinary income in subsequent tax years until they are exhausted.
Should I sell stock at a loss for taxes? ›
“If a good part of your portfolio is up in value, while a smaller part is down,” Curtin says, “selling some of those 'down' investments at a loss — known as tax-loss harvesting — could help offset the tax you owe from the gains earned on your sale of better-performing stocks.” What's more, if your capital losses are ...
What happens when you sell a stock for a loss in an IRA? ›
If you sell the stocks at a loss, you will be allowed to deduct the losses incurred against the gains in a taxable brokerage account. However, if you sold stocks at a loss in an IRA, you won't be allowed to claim the losses against the gains reported in the IRA.
Can you lose your contributions in a Roth IRA? ›
Despite the advantages, you can lose some or all of the money you put into a Roth IRA. One possible reason for a decline in the value of a Roth IRA is market volatility. Other losses can be attributed to early withdrawal penalties and investment fees.
How many years can you carry forward a tax loss? ›
In general, you can carry capital losses forward indefinitely, either until you use them all up or until they run out. Carryovers of capital losses have no time limit, so you can use them to offset capital gains or as a deduction against ordinary income in subsequent tax years until they are exhausted.
