I'm not sure I understand tax loss harvesting

[dualstow]

I understand the basic concept of tax lost harvesting (TLH). You let Uncle Sam share in your losses by selling a fund and buying a similar but not identical fund. When the wash sale period of 31 days is past, you can always buy back shares of the exact fund you sold.

I think short term losses count against gains and long term losses count against ordinary income, or something like that.
And losses carry forward to future years. You can use $3,000 of losses each year?

What I don't understand is if you need a high tax bracket to take advantage of TLH. If you're in a high bracket, the benefits are clear.
If you're not, but you expect to be in a higher bracket in the future thanks to your compounding investments, should you still take advantage of TLH now? Or should you wait until you're in one of the top brackets?

Or, is the jury not out on that?

[Tyler]

Let me see if I can explain it clearly.

When you take an investment loss, you can apply 100% of it towards capital gains and $3000/year towards ordinary income. If you have any losses left over, they carry forward indefinitely and the same rule applies in every subsequent year. So one big loss year can negate all capital gains for quite a while.

As I understand it, once you have carryover losses it's NOT an option to decline to apply them to a gain and "save them for later". You have to keep using them as you go.

[dualstow]

Thank you Tyler.

What if you have some losses built up but you don't really sell anything for several years? And, you're in a fairly low tax bracket. (I'm usually in the 15% bracket. Large savings, low income). You don't generally pay taxes on dividends & interest because they're below the threshold.
Will the losses then get saved for when you do take gains?

[Tyler]

$3k of the losses will be applied against your ordinary income every year, but the remainder will carry over perpetually until you use it. You just have to be sure to report the carryover every year on your taxes. I use Turbotax, which does that automatically.

[dualstow]

Thanks again.
Much appreciated.

[Xan]

What I don't understand is if you need a high tax bracket to take advantage of TLH. If you're in a high bracket, the benefits are clear.
If you're not, but you expect to be in a higher bracket in the future thanks to your compounding investments, should you still take advantage of TLH now? Or should you wait until you're in one of the top brackets?

Or, is the jury not out on that?

I've had the same questions, and I think the answers (as usual) depend on your situation. In general, the arguments for loss harvesting would be something like:

* The old saw "a tax deferred is a tax not paid". Something along the lines of "a bird in the hand is worth two in the bush".
* If you're saving for retirement, then it's fairly likely that when you ultimately sell these investments, you'll have low income.
* If you end up with high income in the future, then paying the taxes won't really be a problem. Think of it as insurance that you pay for out of your potential high income future self to your potential low income future self.
* When you die, your heirs automatically get the cost basis of your assets stepped-up. So if you do end up dying (either very old or unexpectedly) after harvesting, then your heirs come out way ahead.

[dualstow]

* If you're saving for retirement, then it's fairly likely that when you ultimately sell these investments, you'll have low income.
* If you end up with high income in the future, then paying the taxes won't really be a problem. Think of it as insurance that you pay for out of your potential high income future self to your potential low income future self.

That's true. I guess it's possible that I'll still have low income, even though it will be sufficient to live on.