Selling stocks at a loss can be a tough decision to make: no one wants to admit that they made a bad investment. Come tax time, however, strategically realized losses can help lower your capital gains tax liability, thanks to a strategy known as tax loss harvesting.

With tax loss harvesting, an investor sells a security at a loss, and by realizing that loss, offsets some of the taxable gains from the same year. The investor then typically replaces the security they sold with a similar one, in order to  remain in line with their target asset allocation, while taking care to avoid wash sales.

“It makes sense if you have a lot of short term gains,” says Mark Tan, a financial advisor at Thrivent Financial.

 

Higher earners benefit more

Investors in higher income tax brackets see more benefit from tax loss harvesting, as they typically have a higher capital gains tax rate and have more liquid assets to invest.

According to Aaron Gubin, head of research at SigFig, this strategy is most beneficial for investors who have taxable accounts exceeding $100,000 and make reasonably large, continual deposits throughout the year.

That’s because any time an investor sells a stock to realize a loss, they effectively reset their cost basis to a lower level. In order to perform tax loss harvesting again, that investor should purchase stocks at a higher price in the future, and then sell again at a loss further down the road, to offset the gains. (If it sounds complicated, it can be. Investors considering this strategy should consult with a tax or accounting professional for advice pertaining to their specific situation.)

According to SigFig data, 26% of investors with portfolio values between $250,000 and $1 million engaged in behavior indicating possible tax loss harvesting in 2014 (they executed 30% or more of their annual trades in December). Among investors with portfolio under $250,000, only 11% engaged in this type of behavior.

 

Think of tax-loss harvesting as an year-round strategy

Many investors engage in tax loss harvesting at the end of the year, but it should really be a year-round strategy, according to John Sweeney, executive vice president of planning and advisory services for Fidelity Personal and Workplace Investing. “There is market volatility all year that presents opportunities,” he says.

However, investors should be aware of the costs, such as transaction fees incurred when making trades, or redemption fees charged by some funds if a position is eliminated during a holding period.

Additionally, wash sale rules prevent investors from claiming a loss on a security, if they end up buying it again within 30 days of selling it.

At the end of the day, while tax events matter, investors should not make moves solely for the sake of reducing their taxes. Selling a stock at a loss just to offset gains means you might miss out on appreciation in the future. “Don’t let the tax tail wag the investment dog,” says Sweeney. “Make your investment decision first, and think about the tax consequence second.”

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.