What is Tax Selling?

Tax selling is a process where owners of securities try to take advantage of a loss in value. While realizing losses is not necessarily something that people like to do, it can be utilized to offset all or part of a capital gain that has been realized in another investment. In this way, the tax liability for that year can be significantly reduced.

Often going by the name of tax-loss selling, the December period is typically the time that this transaction occurs. This is when investors typically have a clearer picture of what their capital gains situation is for the year. One of the keywords in this process is "realized," as there are no tax consequences for gains until the asset is sold.

The first step in the tax selling process typically is to look at the portfolio of other owned stocks, bonds, mutual funds, or other assets to determine if any are currently trading below the price that was paid. This is done after first figuring out that capital gains will in fact be realized for the year on one of the holdings. If there is a loss on parts of the portfolio, these can become candidates for generating capital losses through tax selling, helping to offset the capital gains.

It can be important to point out that whatever is sold a similar item cannot be purchased within 30 days. This is known as the wash sale rule which states that if an essentially similar investment is purchased within 30 days of the sale of the original, the loss taken cannot be utilized to offset any gains. A similar investment could be selling the stock of one computer hardware company while buying the stock of another. For this reason, the decision of what to sell typically needs to be carefully considered.

The final step in tax selling is to execute the sale of the asset that the owner is willing to part with in order to capture the loss and offset the gains realized elsewhere. Tax selling can be a critical piece of anyone's year-end tax planning, because the goal of most is to minimize the amount of money that needs to be paid to the federal government. It is often a good idea to consult with a tax professional in order to determine if this strategy is correct for a particular investor.

For the most part, the tax selling process is typically straightforward. The last day for tax selling is the final trading day of the year in order for the loss to be considered for the current year's taxes. Although the trade may settle after the first of January, it is the trade date that matters at tax time.