Do You Net Long-Term Capital Gains and Losses?

Selling investments for more than what you paid for them could lead to a tidy profit. It could also trigger capital gains tax, potentially resulting in a larger tax bill. The good news is that you may be able to minimize what you owe through tax-loss harvesting. Knowing how to net short- and long-term capital gains and losses is an important step. You can also work with a financial advisor who can advise you on a good tax planning strategy for your investments.

How Capital Gains Tax Works

Capital gains tax applies when you sell an asset for more than your cost basis or what you paid for it. That includes stocks, other securities and tangible assets such as a home. The Internal Revenue Service (IRS) assesses capital gains based on how long you held the asset.

Short-term capital gains tax applies to assets held for less than one year.
Long-term capital gains tax applies to assets held longer than one year.

Short-term capital gains are taxed the same as ordinary income. So, if you’re in the 24% tax bracket for income, that same rate would apply to any short-term capital gains you report on your tax return. The long-term capital gains tax rate is 0%, 15% or 20%. The rate you pay depends on your filing status and household income. Capital gains and capital losses are reported on Schedule D of IRS Form 1040.

A capital loss means that you sold an asset for less than what you paid for it initially. For example, say you purchase 100 shares of stock at $50 each, then later sell them for $40 each. The $10 difference per share is your capital loss on the investment. Capital losses are not taxed. Moreover, they can be used to offset capital gains through tax-loss harvesting, which can help to offset your tax liability.

What Is Tax-Loss Harvesting?

Tax-loss harvesting is the process of using capital losses to balance out capital gains on your tax return. The IRS allows you to deduct all of your capital losses against capital gains for the year. If capital losses exceed capital gains, you can deduct an additional $3,000 (or $1,500 if married filing separately) from your taxable income. Additional loss amounts can be carried forward to future tax years.

Harvesting capital losses can be an effective strategy for minimizing what you owe in taxes on your investments. For example, say that you sold 100 shares of stock and collected a $10,000 profit. You could sell shares of another stock you own at a loss of $10,000 to cancel out that gain.

There is a caveat, of course, as the IRS doesn’t want investors abusing this tax benefit. The wash-sale rule prevents you from selling an investment at a loss, then buying a “substantially similar” one 30 days prior to the sale date and 30 days after. If you break the wash-sale rule, you lose any tax benefits associated with harvesting losses.

The IRS doesn’t look at individual investments for tax-loss harvesting purposes. Instead, assets are treated as a collective or aggregate and grouped together as capital gains or losses. Specifically, you’ll need to figure out your net capital gain and loss for the year. So how do you net long-term capital gains and losses or short-term ones?

The process works like this:

Identify your short-term and long-term capital gains and losses for the year across all of your assets.
Add all long-term capital losses and long-term capital gains to find your net long-term position.
Add all short-term capital losses and short-term capital gains to find your net short-term position.
If both your net short- and long-term positions are the same, there’s nothing else you need to do. If they’re different, meaning one is a gain and one is a loss, you’d find the difference between them to see if you have a gain or loss for the year.

The end result determines what you report on your taxes and what, if anything, you’re able to offset from your capital gains.

Netting Capital Gains Examples

There are different ways the tax implications can play out when netting capital gains and losses. For instance, say you have a net short-term gain and a net long-term gain. In that scenario, you’d pay ordinary income tax on the short-term gains, then the applicable long-term gains tax rate on your net long-term gains.

What if you have a net short-term gain and a net long-term loss? The net loss could be deducted from your net gains. If gains are more than losses, you’d pay the short-term capital gains tax rate on the difference. If losses are more than gains, you could deduct an additional $3,000 from your taxable income and carry forward any remaining amounts to future tax years.

When net gains outweigh net losses, the tax rate that applies depends on whether the gain is short-term or long-term. If long-term gains are greater than short-term losses, for instance, you’d be able to take advantage of the more favorable long-term capital gains tax rate.

If you have a net short-term loss and a net long-term loss, you can deduct up to $3,000 in losses from your taxable income. Since there are no gains to offset, you’d be able to carry over any remaining losses to future tax years. You’ll want to carry them over separately as short-term and long-term losses since that can affect tax calculations on later gains.

Is Tax-Loss Harvesting Worth It?

Harvesting losses from net capital gains and capital losses could be worth it if it allows you to lower your tax bill for the year. Not only could you cancel out any tax liability associated with capital gains, but you could also reduce your taxable income by up to $3,000 per year.

However, it does require some work as you’ll need to net your short-term and long-term capital gains and losses. That may not be an issue if you allow someone else to prepare your taxes for you. What you have to consider is how much value you might get by harvesting losses. If you’re selling an investment purely to offset a gain, for example, that decision could cost you in the long term if the stock you sold appreciates significantly in value down the line.

You also have to be mindful of the wash-sale rule. One of the more frustrating points of the rule is that the IRS doesn’t specify what it considers to be substantially similar investments. That means misjudging the nature of an investment could result in missing out on any loss-harvesting benefits if the IRS doesn’t view it as being different from the one you sold.

The Bottom Line

A good tax planning strategy can help you hold on to more of your investment dollars. Understanding the value of tax-loss harvesting and what’s involved with netting gains and losses could be a good way to minimize your tax bill. Working with a professional can be beneficial as you plan out how to make the best of your tax plan for your investments.

Tips for Investing

Consider talking to a financial advisor about what you can do to make your investment portfolio more tax efficient. If you don’t have a financial advisor yet finding one doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’d like to make tax-loss harvesting as simple as possible, you might consider investing through a robo-advisor platform. Robo-advisors offer customized investment portfolios that you can grow through automatic investment. Some robo-advisor platforms offer the added benefit of tax-loss harvesting, along with automatic rebalancing, in order to help you get closer to your financial goals with minimal stress.