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Highlights
- Tax-loss harvesting is a method used to minimize tax on capital gains.
- In tax-loss harvesting, you save on taxes by harvesting losses.
- It involves selling underperforming shares at a loss to reduce the tax liability of a portfolio.
People hate to lose their money but tax-loss harvesting can provide you at least a tax benefit by offsetting some losses. Here we will learn about what tax-loss harvesting is.
Tax-loss harvesting
Tax-loss harvesting is a method used to minimize tax on investments. It can help in increasing wealth accumulation. Whenever a person invests in equities and securities and is successful, they get capital gains. Tax-loss harvesting is a method that is used to minimize tax on your capital gains.
Also read: Why do some investors prefer dividends over long-term capital gains?
You sell your underperforming shares at a loss to reduce the tax liability of your portfolio in tax-loss harvesting. It is a method that is used for offsetting capital gains tax on equity securities.
Tax-Loss Harvesting is also called tax-loss selling. Generally, one applies this method at the end of a financial year, but it can also be applied at any time in a tax year.
For example, imagine you made C$ 100,000 in short-term capital gains (STCG) in a year and need to pay 15 per cent of this in taxes i.e., C$ 15,000. But then if you own securities that have an unrealized loss of C$ 60,000, then you can sell these securities to minimize your net short-term capital gains to C$ 40,000. Finally, you need to pay 15 per cent of only C$ 40,000 i.e., C$6,000 that will save C$ 9,000 in taxes.
Also read: What is Earnings Before Interest and Taxes (EBIT)?
What are long-term capital gains and short-term gains?
Long-term capital gains (LTCG)
It involves selling securities that were owned for more than a year to get profit. It can be used for offsetting long-term gains in the future.
Short term capital gains (STCG)
Short-term capital gains involve earning profit from selling those assets that were owned for a year or less.
Investors who derive profit from the money that they hold in an individual retirement account (IRA) need not pay any STCG taxes on that investment. If they withdraw the money from the IRA, then they are taxed at the taxpayer's ordinary income tax rate.
Also read: Canada’s Big Five bank stocks to buy & hold long term
How it works?
Some shareholders use tax-loss harvesting at the end of a calendar year but it can also be used at any time in a tax year. This involves the selling of a security which experiences a consistent price reduction.
If you feel that a particular stock or an equity fund’s value has been decreasing and the chances of recovering these are rare, then you can offset your capital gains tax owned on your portfolio by selling these at a loss.
Bottom line
Tax-loss harvesting is an effective method where one can benefit from a fall in the value of an asset held by selling those securities. It is considered a critical method that can reduce taxes that you pay on equity investments.
