Certified Financial Management Specialist Practice Exam

What does Tax Gain-Loss Harvesting involve?

1. Investing in tax-free bonds

2. Distributing profits among shareholders

3. Using losses to offset capital gains tax

4. Claiming housing deductions

The correct answer is: Using losses to offset capital gains tax

Tax gain-loss harvesting involves strategically selling securities at a loss in order to offset capital gains and reduce an investor's overall tax burden. When an investor realizes capital gains from the sale of securities that have appreciated in value, they may incur a tax liability based on the profit made. By harvesting losses—selling other investments that have declined in value—investors can effectively use these losses to offset the gains, thus reducing the taxable income that results from those capital gains. This strategy is particularly important because it allows investors to minimize tax liabilities while still remaining invested in the market. After selling the loss-making investments, investors can often repurchase similar securities, maintaining their investment positions but at a potentially lower tax cost. This approach can lead to an overall more favorable tax outcome when it comes time for tax filings. Other choices present alternative financial concepts but do not pertain to the mechanism of gain-loss harvesting. Investing in tax-free bonds pertains to managing investment income without tax implications, distributing profits among shareholders deals with corporate earnings processing, and claiming housing deductions relates to individual tax matters but not directly to the investment strategies involving capital gains and losses.