Many investors are preparing for potential market volatility driven by shifting global trade dynamics, particularly concerning tariffs. The ongoing impact of tariffs has the potential to create significant market swings. If you're concerned about how this might affect your portfolio, one strategy you should consider is tax loss harvesting. Optima Tax Relief reviews what tax loss harvesting is and how taxpayers can use it to combat tariff volatility.
What Is Tax Loss Harvesting?
Tax loss harvesting is the process of selling investments that have declined in value to offset gains you've made elsewhere in your portfolio. These realized losses can be used to reduce your overall taxable income, which can lower the taxes you owe for the year.
For example, if you sold a stock for a gain of $10,000 but had another investment that lost $5,000 in value, you could sell the losing investment to offset the gain, thus reducing your taxable gain to $5,000. If you have more losses than gains, you can use up to $3,000 of those losses to reduce ordinary income on your tax return. Any remaining losses can be carried forward to future years.
How Tariff Volatility Can Affect Your Portfolio
Tariffs and trade tensions can impact various industries differently, and the effects of those changes may create opportunities or risks for your investments. For example:
- Sectors heavily reliant on international trade—such as technology, automotive, and manufacturing—may experience price fluctuations as supply chains adjust to new tariffs.
- Companies with foreign operations might face higher costs, impacting their bottom line.
- Commodities, such as steel or agricultural products, can experience significant price shifts as tariffs are imposed or lifted.
In 2025, when tariffs create sudden declines in the value of some of your investments, tax loss harvesting can help you turn those downturns into tax-saving opportunities.
How to Use Tax Loss Harvesting in a Volatile Market
1. Monitor Your Investments Closely
Start by keeping a close eye on your portfolio, especially those sectors and companies likely to be most affected by tariff changes. If you see any positions that have declined in value, assess whether it might make sense to sell them for tax loss harvesting purposes.
The key to tax loss harvesting is timing—selling at the right moment to lock in a loss. While it's important to act quickly in volatile markets, be sure to avoid knee-jerk reactions. Instead, consider the long-term implications of your investment strategy before deciding to sell.
2. Offset Gains with Losses
The goal of tax loss harvesting is to use your investment losses to offset capital gains you've realized during the year. If your portfolio has gains from previously successful investments, selling underperforming stocks due to tariff volatility could help reduce your overall taxable income.
For example, if you made $20,000 from a winning investment but suffered a $10,000 loss from a stock impacted by tariffs, you could sell the losing stock to offset half of your gain. This reduces your taxable gain to $10,000, meaning you'll only owe taxes on that amount.
3. Be Aware of the Wash-Sale Rule
A critical thing to remember when tax loss harvesting is the wash-sale rule, which disallows you from claiming a tax deduction on a loss if you purchase the same or “substantially identical” security within 30 days before or after the sale. This rule prevents investors from selling a stock at a loss just to claim the deduction, then quickly buying it back.
However, you can still sell a losing investment and reinvest in a similar but not identical asset. For example, if you sell a particular tech stock that has dropped in value, you could invest in another tech stock that is not identical, thus maintaining your exposure to the sector while still benefiting from the loss.
4. Offset Ordinary Income with Losses
In addition to offsetting capital gains, tax loss harvesting can help offset up to $3,000 in ordinary income per year. This is particularly useful if you've had a particularly volatile year in the stock market due to tariff-related fluctuations. By strategically realizing losses, you can reduce the amount of taxable income on your return, helping lower your overall tax liability.
If you have more than $3,000 in losses, the remaining balance can be carried forward to future tax years. So, even if you don't need all the losses this year, you can use them in subsequent years when they might be more beneficial.
5. Reinvest for Long-Term Growth
Once you've sold your losing investments, it's essential to consider reinvesting the proceeds to keep your portfolio aligned with your long-term financial goals. While tax loss harvesting can provide short-term tax relief, your investments should always be managed with a view toward achieving long-term returns.
Rebalancing your portfolio and reallocating funds to sectors with greater potential for growth—such as technology or renewable energy stocks, which may be less affected by tariffs—can help set you up for future success.
Final Thoughts
In a year marked by tariff volatility and shifting global trade policies, tax loss harvesting can be a powerful strategy to reduce your tax burden while managing risk in your investment portfolio. By taking advantage of market downturns, you can offset taxable gains and reduce your overall tax liability.
