Kapadia LLP CPAs

Tax season will be here before we know it. And that means being on the lookout for strategies that can minimize tax liabilities. One strategy is tax-loss harvesting. By selling investments that have decreased in value, you can use these losses to offset taxable gains and possibly reduce your business’s overall taxable income. 

While it’s typically done in personal investments, small businesses that hold investments in securities, stocks, bonds or other financial assets can also use tax-loss harvesting to their advantage. Let’s break down what tax-loss harvesting is, how it works and how it can benefit your business.

What is tax-loss harvesting?

Tax-loss harvesting is a tax strategy that involves selling nonprofitable investments at a loss to offset or reduce capital gains taxes incurred when selling investments for a profit. This can reduce your overall tax bill.

How does tax-loss harvesting work?

Tax-loss harvesting helps investors reduce taxes by offsetting the amount they must claim as capital gains or incomes. In other words, investments are “harvested” to be sold at a loss, and then the loss is used to lower or eliminate the taxes you pay on gains you’ve made during the year.

What are the benefits for small businesses?

There are several benefits of tax-loss harvesting for small businesses, including: 

1. Reducing capital gains tax 

When an asset is sold at a loss, the loss can be used to offset capital gains from other profitable investments. This reduces overall tax liability on gains, lowering the amount your business needs to pay in taxes. 

2. Offsetting ordinary income

If capital losses exceed capital gains, you may be able to deduct up to $3,000 from your ordinary income ($1,500 if married filing separately). Any remaining losses can be carried forward to future years.

3. Improving cash flow 

By reducing taxes, your business will have more cash available for reinvestment to fund operations, invest in growth or pay down debt. 

4. Maximizing investment strategy 

Selling underperforming assets and reinvesting the proceeds helps clean up your investment portfolio and stay aligned with long-term goals.

How do I implement tax-loss harvesting in my business? 

1. Review your investment portfolio 

Identify assets that are currently held at a loss, and pay special attention to those that may have little potential for future recovery. 

2. Time your sales strategically 

If you expect to have high capital gains in a particular year, you may want to plan to harvest losses in that same year to minimize taxes. 

3. Match gains and losses

Use your capital losses to offset any capital gains. Match short-term losses against short-term gains and long-term losses against long-term gains. Short-term gains are taxed at higher ordinary income rates, whereas long-term gains are taxed at lower rates. 

4. Avoid the wash sale rule

The IRS imposes a “wash sale” rule that prohibits you from buying back the same or a substantially identical stock or security within 30 days before or after the sale. If this rule is violated, your tax deduction for loss is disallowed. Note: Wash sales are separately reported to the IRS to ensure compliance with this rule. 

5. Track your losses

Keep accurate records of all transactions, including capital gains and losses for each tax year. This ensures you can claim all allowable deductions and correctly carry forward any unused losses to future years. 

6. Work with a tax advisor

Tax-loss harvesting may seem straightforward, but it’s always a good idea to work with a tax professional or financial advisor who can guide you through the specifics of your business. They can help you determine the best timing, how to maximize the benefits and—most important—ensure compliance with tax rules.

Tax-loss harvesting can be an effective strategy for managing your small business’s tax liabilities. But it requires a thorough understanding and meticulous execution. So, work with a tax advisor to ensure you’re in compliance with the IRS and tax laws. By implementing tax-loss harvesting, you can turn financial setbacks into strategic tax advantages.