Leveraging tax rules for better post-tax investment returns.
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Let’s say a few stocks in your portfolio have really taken off, and you want to cash in and buy yourself a nice car. The only problem is that if you sell these stocks, you’re going to get hit with a big capital gains tax. These are the taxes you pay on the profit in your portfolio.
Here’s where we use tax loss harvesting — an effective strategy to reduce your tax bill but still pull money out from your portfolio.
The gist is: along with selling profitable assets (maybe a technology stock), you strategically sell underperformers (perhaps industrial stocks that have had losses). By offsetting gains with losses, the aim is to minimize net capital gains, ideally reaching a breakeven or even a negative balance, thereby reducing or eliminating capital gains taxes altogether.
Let's illustrate this with an example:
Scenario A: You need $80,000 > you sell your tech stock (bought for $50,000 with a current value of $80,000) > results in $30,000 profit > triggers a tax liability of approximately $7,000 (accounting for your marginal tax rate).
Scenario B: You need $80,000 > you sell half your winning tech stock (earning a profit of $15,000) > you sell half your losing industrial stock (at a loss of $15,000) > your tax bill reduces to zero
A few caveats:
- Tax loss harvesting is inapplicable to registered accounts such as the TFSA or RRSP
- For index fund-only investors, this strategy may not work as you might only have a few investments and will likely incur a capital gains bill every time you need to unlock funds
In summary, tax loss harvesting offers a pragmatic means to divest from both winners and losers strategically, thereby optimizing tax efficiency and preserving more of your hard-earned returns.