This has been a tough year for individual stock investors, but there is still a little good news even when some market indices percentages are down by double digits. That’s because those assets may be sold at a loss to help you offset gains in other stocks. They can also help you offset some of your income. The practice is known as tax loss harvesting. It’s a fairly common practice, but there are some things you should understand before you engage in it.

How Tax Loss Harvesting works

Let’s say you have $10,000 in capital gains in a certain stock. We’ll call it Stock A. This stock happens to be an energy stock. Looking at your portfolio, you realize it has too many energy stocks and needs to be rebalanced. Stock A is a prime candidate to sell, but you don’t want to pay short-term capital gains. But you have another stock held for less than a year. We’ll call it Stock B. It is down by $15,000. You could sell it and use the loss to offset the $10,000 gain from Stock A. There’s still $5,000 left in losses, so you could apply $3,000 to offset this year’s ordinary income. That leaves $2,000 that can be used to offset future gains or income.

Things You Should Know about Tax Loss Harvesting

Using a loss to counterbalance current and future gains may sound too good to be true. Well, that is partially correct. There are limitations to tax loss harvesting. One of the more significant ones is you cannot deduct losses in a tax-deferred account. That’s because you are already generating income in these accounts by paying taxes later, if at all. So, your average retirement account is off the table. Also, any losses you take must be applied to that type of gain. Looking at the previous example, both Stock A and Stock B were held for less than a year. So, they would be considered short-term losses and gains. They would be applied to each other first, under IRS rules. Any excess losses after that would be applied to either short or long-term capital gains.

It’s worth noting that there is a significant difference in tax rates on short-term and long-term capital gains. Check out these tables when considering if the tax loss harvesting is appropriate in your situation.

One more important item to consider is the wash sale rule. This rule states that if you sell a security at a tax loss and then buy that same security or a significantly identical one within 30 days, you could lose some or all of the tax loss benefits.

Have a plan for tax loss harvesting

Sometimes tax loss harvesting can be straightforward. In other situations, it may be more complicated. So, it’s important to have a strategy in place regardless of your financial circumstances. It’s probably worth consulting a CPA to determine if tax loss harvesting is a good move for you. You may also want to consider getting help from a fiduciary financial advisor.

There are quite a few things to consider in tax loss harvesting. Still, with a strategy, some additional research, and help from tax and finance professionals, you should be able to determine if it’s the best tax move for you this year.