It may seem better to recognize a gain on an investment rather than a loss. However, sometimes selling an investment at a loss may be prudent. Selling a security at a loss can be smart when its outlook for growth is no longer promising, doesn't fit an investor's evolving strategy, or if losses can be paired with gains to manage taxes.
Tax-loss harvesting is the product of a two-step netting process, handled by the tax preparer, which classifies capital gains and losses into:
STEP 1: Short-term capital losses are netted against short-term capital gains, while long-term capital losses are netted against long-term capital gains.
STEP 2: Net short-term capital losses are offset against net long-term capital gains, or, if applicable, net long-term capital losses are netted against net short-term capital gains.
If there are any remaining net capital losses after Step 2, up to $3,000 can be offset against higher-taxed ordinary income in a given tax year. Any "unused" losses beyond that can be carried forward, for use in future tax years as long as the taxpayer is still living. In tax-loss harvesting, the benefit comes from offsetting capital gains with capital losses, thus reducing the taxes due when selling investments.
Managing high concentrations of employer stock
Fluctuations in stock price over time can lead to an employee holding their company's stock in multiple lots with different cost basis for each. Also, a substantial proportion of the employee's wealth may be concentrated in company stock. As an investor, this may leave the employee with a dilemma:
- Sell appreciated shares for a substantial capital gain, resulting in the realization of capital gains taxes;
- Sell shares at a loss; or
- Hold company shares and avoid income taxation, but maintain an investment position concentrated in one company.
Tax-loss harvesting is a way to mitigate these issues. They are not mutually exclusive, but when these issues are addressed together, via tax-loss harvesting, an employee could be in a better position as far as realizing taxes and addressing their concentration in employer's stock.
Tax-loss harvesting could be useful for participants with some grants holding unrealized gains and others with unrealized losses. By selling some positions with gains and others with losses, overall capital gains taxes can be reduced. The proceeds of the stock sales can be used to create a more diversified portfolio, applied to other financial goals, or used for near-term cash flow.
Your Fidelity Executive Services℠ team can help you diversify your portfolio, manage concentration risk, and answer key questions.