Tax Selling: Definition & How it Works
Tax selling has to do with an investor choosing to sell a particular asset with a capital loss. They do this to try and either eliminate, or reduce, the capital gain realized by other investments.
Read on as we take a deeper look at tax selling.
Table of Contents
- Tax selling is a strategy an investor can use to try and reduce their total income tax.
- Tax selling involves an investor selling a specific asset at a capital loss in an attempt to either eliminate or reduce their capital gains.
- The Internal Revenue Service (IRS) prohibits investors from taking part in wash sales. This is when an investor sells a stock and repurchases a similar asset simultaneously within 30 days before or after the sale.
What Is Tax Selling?
Tax selling refers to a sale scenario where an investor sells a capital loss asset to reduce, or even eliminate, the capital gain from other investments for tax purposes. The investor can avoid paying capital gains tax on recently sold or appreciating assets through tax selling.
Essentially, it’s a type of sale that’s intended to benefit the investor for income tax purposes. The investor can then avoid having to pay any capital gains taxes on assets that have recently been sold or appreciated.
What Is the Purpose of Tax Selling?
The main purpose of tax selling is to try to either eliminate or reduce the capital gains from an investment for income tax purposes. An investor will try and sell a stock at a loss, ultimately trying to lower the capital gain.
Since capital gains are tax-deductible, the investor will then be able to offset them to reduce their overall tax liability. Tax selling will allow the investor to keep their position since it often includes investments with substantial losses.
How Does Tax Selling Work?
Tax selling is the process of selling off a stock at a loss to try and reduce the potential capital gain you would earn on an investment. Capital losses are tax deductible, so you can use them to help offset the capital gains, ultimately lowering your tax liability.
With all of that said, there are a few things to keep in mind when it comes to tax selling. Achieving tax-deductibility of losses could potentially lead to an investor deciding to sell at a loss. The investor might then decide to deduct the loss and purchase the same stock again right away. This is known as a wash sale and it’s a tactic to try and evade taxes.
The Internal Revenue Service (IRS) strictly prohibits an investor from carrying out a wash sale. If the IRS determines an investor has taken part in a wash sale, they would not be eligible for any of the potential tax benefits they would have otherwise been eligible for.
What Does Tax Selling Mean for Investors?
Tax selling for investors means they can try to offset their capital gains to reduce their total income tax. After the selling season is completed, any shares that end up being oversold can bounce back.
Most tax selling happens in the later months of the calendar year since investors want to try and realize their capital losses for the next tax season. In this case, investments with the potential for strong gains at the beginning of the next tax year might be the best securities to go after.
Investors can use the strategy of buying during the tax selling episode, and then selling after any tax loss gets established. After the 30-day wash sale rule passes, investors can then repurchase the shares they previously sold for a loss.
Tax selling is a specific type of sale that investors use to help offset capital losses. They do this to try and either eliminate or reduce their realized capital gains for income tax purposes. Ultimately, tax selling allows investors to avoid paying capital gains taxes on any appreciated or recently sold assets.
A wash sale occurs when an investor chooses to sell a stock, and then simultaneously repurchases the same asset, or substantially identical, within 30 days before or after the sale. Investors are prohibited by the IRS from taking part in a wash sale. If you do have a wash sale, the IRS will not allow you to claim a loss for that asset on your current-year tax return.
FAQs About Tax Selling
Is Tax-Loss Selling Worth It?
It can depend on the specific stock and the strategy in place. Investors can sell non-registered investments and assets that have dropped in value, so tax-loss selling can definitely be worth it.
Is Tax-Loss Harvesting Illegal?
Tax-loss harvesting is a completely legal strategy to help lower current federal taxes. It’s done by taking on capital losses to offset taxes owed on capital gains.
How Much Can You Sell Without Paying Taxes?
This depends on the specific stock and the type of sale. However, a general rule can be net earnings that are equal to taxable business income, minus any allowable deductions.
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