When it comes to investing, most people focus on growing their portfolio. You want to pick the right stocks, bonds, or funds, and make the right decisions to be and remain profitable. Whether you’re preparing for retirement or aiming for financial stability, investments matter.

But what if you could also strategically reduce your tax bill while doing it? This is where tax-loss harvesting comes into play. It’s a smart tactic that uses your portfolio’s declining or losing moments to your advantage, potentially saving you thousands over time.

Let’s break down how you can use this tactic and maximize your savings.

What Is Tax-Loss Harvesting?

In simple terms, tax-loss harvesting is the practice of selling investments that have dropped in value to offset capital gains that you’ve made from other investments. The idea is to use your losses to cancel out some of your taxable gains.

For example, if you made $10,000 in profits from one stock but lost $4,000 on another, selling the loss-making stock allows you to subtract that $4,000 from your gains. Normally, you would be taxed on the $10,000 that you have made, but by selling the loss of $4,000, you will only be taxed on $6,000 instead.

So, technically, you have maximized your savings by reducing your capital gains tax.

How It Works in Your Favor

The benefit of tax-loss harvesting is that it reduces the amount of tax you owe without impacting your overall investment strategy. After selling the loss-making investment, you can reinvest in something similar so you remain in the market.

One thing to note here is that you must not reinvest in an identical stock. This is to avoid breaking IRS “wash sale” rules. It’s best to familiarize yourself with the basics as well as the intricacies by getting tax loss harvesting explained through a guide.

Platforms like Creative Planning not only offer financial services but also have comprehensive information about such topics. Keeping yourself well-informed can help keep your portfolio aligned with your goals while still taking advantage of tax savings.

Some advantages include:

Lower Tax Bills

The primary perk is obvious and straightforward. With tax-loss harvesting, you get to pay less in taxes on your investment gains. The result? You save more than you pay.

Offsetting Ordinary Income

If your losses exceed your gains, you can use up to $3,000 of that excess to reduce your taxable income for the year.

Carry Forward Losses

If you still have unused losses after that, they can be rolled over to future years until they are fully used.

How to Do It Right

While the concept sounds simple, timing and selection matter. To prevent any unavoidable mistakes, keep three things in mind.

Remember the wash sale rule. Don’t sell an asset at a loss and then buy the same or a “substantially identical” one within 30 days before or after the sale.

Focus on strategy and not just tax savings. Don’t sell just for a quick tax break if it hurts your long-term investment plan.

Work with a professional. A tax advisor or financial planner can help you structure your moves for maximum benefit.