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’s 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 then 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 buy 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 who have lots of positions, tax loss harvesting can be tedious. Most brokerages now automate the tax loss harvesting process. 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 in 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 not eligible for tax loss harvesting. Roth IRA contributions go in as after-tax funds. 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.
Tax loss harvesting generally applies to short-term capital gains, but may also offset long-term capital gains.