Because the stock market is up significantly so far in 2013 (even taking into account the recent correction), many investors haven't started to think about tax-loss selling. But if you have underperforming investments in your portfolio, especially among bonds and bond funds, which have fallen dramatically in price recently, then you'll have the opportunity to benefit from this strategy -- and beat other investors to the punch in the process.
Why Tax-Loss Selling Is Off the Radar
Last year's fiscal-cliff drama changed the usual rules on tax strategies. Because of the anticipated tax increases that took effect at the beginning of 2013, many taxpayers actively tried to increase their taxable income in 2012 in order to reduce the amount of income they'd have to pay higher tax rates on this year.
As a result, many taxpayers actually deliberately took tax gains, selling off stock on which they'd earned a profit.
But this year, with no further anticipated hikes in tax rates on the table, the standard rules apply, and investors should look to make the most of their tax losses.
Why Waiting Isn't Smart
The tax-loss rules give you until the last day of the year to sell shares at a loss and include them on your 2013 tax return. But waiting until then to make tax-loss sales means sacrificing up a couple of valuable benefits.
First, harvesting tax losses is popular enough that it can have a marked impact on a stock's price. If a stock has fallen substantially during the year, those losses often get worse during the fourth quarter as tax-loss sellers dump their shares for whatever the market is willing to pay. Moreover, institutional investors like mutual fund companies often have a different fiscal year, forcing them to consider tax-loss selling by the end of October rather than waiting until the end of the calendar year. Selling early can give you better prices for your stock losers than waiting.
There Are Limits On Losses
Unfortunately, the IRS won't let you benefit too much from tax losses in any given year. You have the ability to use your losses to offset any capital gains you recognize during the tax year. In addition, you can claim up to $3,000 in additional losses, using them to offset other income such as wages, investment interest, and stock and mutual-fund dividends.
But if you have more losses than that, you don't necessarily lose them forever. The IRS lets you carry those losses forward to future years, allowing you to work down any excess losses gradually.
The key, though, is not to let your usual tax procrastination stop you from considering your best tax-loss harvesting strategy right now.
Tax savings won't make up for the pain of those losses, but they will give you an offsetting benefit to help you feel somewhat better about making an investment mistake in the first place.
You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+.