As the end of the year approaches, you may be hearing a lot of talk about capital gains, capital losses, and something called “tax loss harvesting.” A lot of clients ask me about “harvesting” their losses – specifically, how can “losses” be a good thing? Here’s a broad overview, that may help you save a few dollars in taxes:

Capital Gains: If you buy an investment, it gains value, and you sell that investment – you’ve realized a capital gain. The difference between your purchase price and sale price (the gain) is potentially subject to capital gains tax.

Capital Losses: If you buy an investment, it loses value, and you sell that investment – you’ve realized a capital loss.

Adding it Up: As you prepare your taxes, you’ll add up all of your gains and losses to determine your total gain (or loss) for the year. Losses offset gains on a dollar-for-dollar basis. For example, imagine an investor who sold two holdings during the year. In one transaction, she realized a $100 gain. In another, a $90 loss.

                Sold XYZ Stock: $100 Capital Gain

                Sold ABC Stock: $90 Capital Loss

                Net: $10 Capital Gain for the year

In this scenario, the taxpayer would have $10 in capital gains for the year – potentially subject to taxation.

Harvest Season: At the end of the year, many investors review their year-to-date realized gains and losses. If they have significant capital gains, and are therefore worried about a tax bill, they look over their remaining holdings. Finding investments that have lost value (and that they don’t mind selling) can help to decrease the capital gain total. By selling those holdings, an investor is “harvesting” a loss for strategic tax purposes. It is important to note that a lot of the rules surrounding gains/losses vary. There is further nuance surrounding the holding period of your investment (short term vs. long term), the treatment of excess losses, and the taxability of capital gains. Depending on your income and tax filing status, the above outline may or may not apply to you in full. To examine your own situation, consult your tax preparer or talk with your fee only financial planner.