So, I started with the idea of creating a short guide to tax loss harvesting for small businesses, but as I started writing, I realized that tax loss harvesting for small business owners is too complex for “short.”
Instead, I am going to give you a concise and simple explanation of loss harvesting. There’s plenty of detail if you want to be overeducated, but you can read the next two paragraphs if you just want to know, “What is tax loss harvesting?”
What is tax loss harvesting?
Tax loss harvesting for small businesses is the process of selling a security at a loss for tax reduction, both for capital gains and regular income. I address both instances below.
Note: I call this strategy loss harvesting; some call it “investment loss harvesting.” Today, we’ll stick to the preferred terminology: “tax loss harvesting.”
Use tax loss harvesting for capital gains tax reduction.
First, we’ll talk about how you can use tax loss harvesting to reduce capital gains taxes.
Let’s say that you’re in the 24% tax bracket, and you have bought $100,000 worth of securities in a taxable account. Now, the value of that $100,000 investment has dropped to $93,000 within the year.
You may opt to pursue a tax loss harvesting strategy. In that case, you would sell, recognizing a $7,000 capital loss. You would then use the proceeds from this sale to purchase another selection of securities, and you would use the $7,000 capital loss to offset any capital gains you realized within the year.
Or use capital losses to reduce income taxes.
What if your capital loss exceeded those capital gains taxes?
Let’s say you have $4,000 in capital gains by selling, recognizing, or realizing the value of some other security. You could offset that amount (remember that you have $7,000 in capital losses) and not have to worry about that loss or that gain. You’d still be left with a $3,000 net capital loss, which you could use to offset your ordinary income.
Consider deferring capital gains, as well.
One important point to note is that long-term capital gains tax brackets are almost always more favorable than ordinary income tax brackets.
So, I want to drive home the point that you can get a tax benefit by deferring a gain to future years and potentially taking advantage of a short-term capital gains tax bracket rather than paying ordinary income taxes on it. You’re essentially choosing one or the other.
Be proactive: clean up your portfolio and benefit from tax savings.
Tax loss harvesting is often characterized as an emergency response: “How do I turn a loss into a win?” I want you to think about loss harvesting proactively.
Let’s say you’ve identified underperforming investments; you can sell them and use the proceeds to invest in better opportunities. This approach allows you to offset any realized losses against other gains in your portfolio, effectively decreasing the tax you owe.
Start by connecting financial advisors and tax advisors.
So, how do we come up with a solution to deal with underperforming securities or funds in your portfolio? As a certified public accountant (CPA), I cannot legally advise you on that matter. Your certified financial planner (CFP) cannot advise you on the tax side. Let’s connect the two. Facilitate communication between the people who manage your money. (Note: My clients access a network of partner firms specializing in finance, investments, legal, and retirement.) We can turn unrealized losses into realized losses to clean up your portfolio.
These concepts—tax gain harvesting and tax loss harvesting—are essential tools for investors. However, it’s important to keep in mind some practical considerations related to their application, which we will explore next.
Here are some additional points about tax loss harvesting for small businesses.
Tax loss harvesting doesn’t differentiate between asset classes when adjusting for short-term and long-term gains. Gains and losses from equities, debt, real estate, and even commodities can be offset against each other. This broader applicability makes tax loss harvesting a versatile strategy.¹
Additionally, you can carry forward your losses for up to eight financial years; this means that even if tax loss harvesting leads to a net loss at the portfolio level, those losses can be utilized against future gains to lower or eliminate tax obligations in subsequent years.²
There are Internal Revenue Service (IRS) regulations that you need to know about.
If you’re going to be using tax loss harvesting as a short-term strategy, you need to be aware of Internal Revenue Service rules. The “wash sale rule” states that an individual cannot sell and then repurchase the same security within a period of thirty days.⁴ Obviously, the intent is to prevent high-volume selling and buying. The IRS provides a simple example:
“The taxpayer buys 100 shares of X stock for $1,000. The taxpayer sells these shares for $750 and, within 30 days from the sale, buys 100 shares of the same stock for $800. Because the taxpayer bought substantially identical stock, the taxpayer cannot deduct the loss of $250 on the sale. However, the taxpayer adds the disallowed loss of $250 to the cost of the new stock, $800, to obtain the basis in the new stock, which is $1,050.”³
The wash-sale rule applies to the majority of investments you have in your brokerage account, and the intent behind the rule is reasonable. High-volume trading is hazardous, to begin with. Tax loss harvesting is another potentially hazardous strategy. The two simply do not mix well.
If a wash sale occurs, report it using Form 1099-B.⁵
If you’re going to pursue short-term loss harvesting, here’s how.
Consider buying a mutual fund or ETF in the same industry. This way, you can retain your market exposure while complying with the wash sale rule. I’m not an investment advisor, so do not take this as investment advice. We’re simply talking about hypotheticals, so if you need to conduct a short-term buy and sell, just remember to comply with regulations.
Let’s end with some common-sense tips on tracking and execution.
There’s a right and a wrong way to pursue tax loss harvesting. The first rule is to track everything you do. The second rule is to treat loss harvesting as part of a broader strategy rather than a fix-all.
Track transactions, gains, and losses.
If you have been actively maintaining records of your transactions, tracking your capital gains should be straightforward but will take some time and diligence to do correctly. Some platforms also offer tax harvesting and tax loss harvesting tools that can automatically track losses and gains.
Despite the availability of these tools, I recommend maintaining a record of all transactions and monitoring capital gains closely. This approach will make managing tax harvesting and tax loss harvesting much easier.
Don’t overplay the strategy.
Now, tax loss harvesting lowers your taxable gains, and you can even book a net loss for a financial year. This loss can be carried forward for up to eight financial years.
However, you must be careful not to overplay the strategy. Selling funds or stocks incur costs, which can reduce the benefits of tax loss harvesting. You may face brokerage fees and other related expenses. Speak to your financial advisor about these matters. From our perspective, it’s a given that our clients will face brokerage fees; remain cautious when selecting funds that come with other fees.
It’s common sense: Accumulated losses shift the focus away from wealth creation and lead to unnecessary trading activities that benefit brokerage firms and do not come with enough tax savings to justify the effort.
Let’s connect you to a network of firms for financial, investment, and tax solutions.
Loss harvesting for small businesses involves complex strategy and implementation. We get wins for our clients because we recognize where we’re the experts and where we’re not. Over the last five years, we’ve partnered with high-performing firms specializing in investment strategies, retirement planning, and legal considerations.
Here’s the long and short of it: we solve problems and deliver solutions—no boundaries, no excuses. Schedule a discovery call today.
Talk soon,
Jeremy A. Johnson, CPA
References
- Tax-loss Harvesting | Capital Gains and Lower Taxes | Fidelity [Internet]. fidelity.com. 2024. Available from: https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting
- Fleming L. The economics of tax-loss harvesting [Internet]. thetaxadivsor.com. The Tax Adviser; 2023 [cited 2024 Nov 9]. Available from: https://www.thetaxadviser.com/issues/2023/sep/the-economics-of-tax-loss-harvesting.html
- IRS Courseware – Link & Learn Taxes [Internet]. IRS.gov. 2024 [cited 2024 Nov 10]. Available from: https://apps.irs.gov/app/vita/content/10s/10_04_011.jsp?level=
- Publication 550 (2018), Investment Income and Expenses | Internal Revenue Service [Internet]. IRS.gov. 2024 [cited 2024 Nov 10]. Available from: https://www.irs.gov/publications/p550
- About Form 1099-B, Proceeds from Broker and Barter Exchange Transactions | Internal Revenue Service [Internet]. www.irs.gov. 2024 [cited 2024 Nov 9]. Available from: https://www.irs.gov/forms-pubs/about-form-1099-b