How to Use Tax-Loss Harvesting to Reduce Investment Taxes

April 01, 2025
How to Use Tax-Loss Harvesting to Reduce Investment Taxes

Introduction

Tax-loss harvesting is a strategic tax-saving technique that allows investors to offset capital gains by selling underperforming investments at a loss. This approach helps reduce overall tax liability while allowing investors to reinvest in similar assets to maintain market exposure.

 

By properly implementing tax-loss harvesting, taxpayers can lower their taxable income, carry forward losses for future years, and optimize after-tax investment returns. This article explains how tax-loss harvesting works, IRS and CRA rules, and the best strategies to maximize savings.

 

1. How Tax-Loss Harvesting Works

  • Investors sell assets at a loss to offset gains from profitable investments, reducing their total taxable capital gains.
  • If losses exceed gains, up to $3,000 ($1,500 for married filing separately) of capital losses can be deducted against ordinary income per year in the U.S.
  • In Canada, capital losses can only offset capital gains, but unused losses can be carried forward indefinitely or carried back up to three years.

 

2. U.S. Tax-Loss Harvesting Rules (IRS)

  • Offset Short-Term Gains First:
    • Short-term gains (held ≤1 year) are taxed at higher ordinary income tax rates (10%-37%).
    • Tax-loss harvesting prioritizes offsetting short-term gains first to maximize tax savings.
  • Offset Long-Term Gains Next:
    • Long-term gains (held >1 year) are taxed at lower capital gains rates (0%, 15%, or 20%).
  • Carryforward Rule:
    • If total losses exceed the annual $3,000 deduction limit, unused losses can be carried forward indefinitely.

 

3. Canada Tax-Loss Harvesting Rules (CRA)

  • Capital losses can only offset capital gains (not ordinary income).
  • Loss Carryback & Carryforward Rules:
    • Losses can be carried back up to 3 years to offset prior capital gains.
    • Losses can be carried forward indefinitely to apply against future gains.

 

4. Wash Sale Rule (U.S.) and Superficial Loss Rule (Canada)

  • The IRS Wash Sale Rule prevents investors from claiming a tax loss if they repurchase the same or substantially identical security within 30 days before or after selling at a loss.
  • The CRA’s Superficial Loss Rule applies similarly, preventing loss claims if an identical security is repurchased within 30 days and still held at the end of that period.
  • Workaround Strategies:
    • Buy a similar (but not identical) asset to maintain market exposure.
    • Wait 31 days before repurchasing the same asset.

 

5. Best Assets for Tax-Loss Harvesting

  • Stocks & ETFs – Liquid and frequently traded, making them ideal for harvesting losses.
  • Cryptocurrency – Currently not subject to the Wash Sale Rule (U.S.), allowing for immediate reinvestment.
  • Mutual Funds – Can be sold and replaced with a similar fund to avoid the wash sale rule.

 

6. When to Use Tax-Loss Harvesting

  • Near Year-End: Harvesting losses before December 31 helps offset taxable gains for the current tax year.
  • In High-Income Years: Helps reduce taxes when taxable income is high.
  • During Market Downturns: Allows investors to rebalance portfolios while generating tax savings.

 

7. How to Implement Tax-Loss Harvesting Effectively

  • Identify underperforming assets in taxable investment accounts.
  • Sell assets at a loss to offset capital gains.
  • Reinvest in similar (not identical) assets to maintain exposure and avoid wash sale rules.
  • Keep detailed records of transactions for tax reporting.

 

8. Tax Forms for Reporting

  • U.S. Investors:
    • Report losses and gains on Form 8949 and Schedule D (Form 1040).
  • Canadian Investors:
    • Report capital gains and losses on Schedule 3 of the T1 General Tax Return.

 

Conclusion

Tax-loss harvesting is a valuable strategy for reducing investment taxes by offsetting gains and minimizing taxable income. Investors should be mindful of IRS wash sale rules (U.S.) and CRA superficial loss rules (Canada) while ensuring proper reporting of transactions. 

 

Tax Partners can assist in developing customized tax-loss harvesting strategies to maximize investment tax efficiency while ensuring compliance with tax laws.

 

This article is written for educational purposes.

 

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

 

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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