Tax-Loss Harvesting
Tax-loss harvesting is the practice of selling investments at a loss to offset capital gains, reducing your tax bill. The proceeds are reinvested in a similar (but not identical) asset to maintain market exposure.
If you sell Stock A for a $5,000 gain and Stock B for a $3,000 loss, you're taxed on only $2,000 of net gain. Capital losses can offset gains dollar-for-dollar; up to $3,000 of net losses can be deducted against ordinary income annually in the US.
The wash-sale rule prevents gaming the system: you cannot buy the same or "substantially identical" security within 30 days before or after the sale. Selling an S&P 500 index fund and buying a total-market index fund is acceptable; selling and immediately rebuying the same fund is not.
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- Capital Gains
- A capital gain is the profit from selling an asset (stock, real estate, crypto, etc.) for more than you paid. In most countries, capital gains are taxed differently from ordinary income.
- Cost Basis
- Cost basis is the original value or purchase price of an asset for tax purposes. Capital gains tax is calculated on the difference between the sale price and the cost basis.
- Effective Tax Rate
- Your effective tax rate is your total tax paid divided by your total income, expressed as a percentage. It is always lower than your marginal rate in a progressive tax system.