Investment losses rarely (if ever) make investors happy. But there are ways to make Uncle Sam share in some of that pain.  The concept of tax loss harvesting is simple. By selling an asset at a loss, investors can use those losses to offset gains on other investments for tax purposes.

Tax loss harvesting is perhaps best shown with an example. Assume an investor purchased a fund on January 1 for $10,000. On March 1 of the same year, it was trading at $7,000. At this point, the investor has decided to harvest the loss. The loss is characterized as short term, since the fund was held for less than one year. If we assume a 35 percent ordinary federal income tax, this will result in a $1,050 tax savings. Because of this tax savings, the economic loss is $1,950.

Tax management of investments is a year-round job.  An investment might have a loss that could be harvested at a given point during the year, but that investment might recover by year-end, thus removing the loss-harvest opportunity.  Also, it can be important to realize short-term losses before they become long-term losses.  A loss should be harvested whenever the value of a tax deduction significantly exceeds the transaction costs of the trades required to harvest the loss, immediately reinvesting the proceeds in a manner avoiding the wash-sale rule.