Every year, typically in November, I devote an article to year-end tax-loss harvesting. I do this in November to remind investors to start thinking about taxes with enough time left in the year that they can develop a plan and execute it.

Taking Some Profits

This year’s big sector winner is energy. Year-to-date, the Energy Select Sector SPDR ETF (XLE) is up 51%. Many energy companies are up triple digits to date. For example, SandRidge Energy (NYSE: SD) has a gain of 273% YTD. There are many such companies in the energy sector with triple digit gains this year. Even a large company like Marathon Oil (NYSE: MRO) is sitting on a 140% gain this year.

It’s hard to say how much longer high oil prices will persist, but it may be a prudent idea to take some profits on your energy holdings. The downside of this is that if you hold such companies outside of a retirement account, you will generate a tax liability.

A short-term capital gain occurs if you held an asset for less for one year before selling it. Short-term capital gains are subject to taxation as ordinary income.

For assets held longer than one year, you will benefit from a more attractive long-term capital gains tax rate. The long-term capital gains tax rates are 0%, 15%, or 20% depending on your taxable income.

Accordingly, one consideration as we head into the end of the year is how long you have held a security. By paying attention to the timing of your sale, you can save yourself quite a lot on your tax bill.

But you can save even more on your tax bill by offsetting those gains with any losses in your portfolio. This is the time of year that you should start to look over your portfolio and make those kinds of strategic decisions.

Tax-Loss Harvesting

If you have a diversified portfolio, every company in your portfolio this year probably wasn’t a winner. AT&T (NYSE: T), for example, is widely held, but shares are down 15% on the year. You can take advantage of a company like AT&T that is in the red to offset those that are in the black. This strategy is called tax-loss harvesting and it can lower your taxable gains.

But it also means that companies that are down for the year can face increased selling pressure in December. That’s why I prefer to do my tax-loss harvesting in late November.

If you sell off your losers and harvest those losses, you can offset dollar-for-dollar your gains. This strategy is especially appealing to limit the impact of short-term capital gains.

You can even sell a losing company that you still like, but be careful about the “wash sale” rule in the tax code. This rule prohibits a taxpayer from claiming a loss on the sale of a security and then buying a “substantially identical” security within 30 days of the sale.

What does “substantially identical” mean? It obviously covers selling and buying back common shares in the same company within 30 days. However, an S&P 500 index fund run by one company may be deemed by the IRS to be substantially identical to an S&P 500 index fund run by another company.

I can’t sell shares of AT&T, claim a loss on the sale, and then buy back shares of AT&T within 30 days. But I could replace my AT&T with shares of Verizon (NYSE: VZ), which is itself down 10% for the year. That would be a way to lock in losses for tax purposes, while maintaining the same sector exposure. The communications sector is one of the sectors that lagged the S&P 500 this year, but it will bounce back. If you do sell a loser, I recommend you maintain the sector exposure unless you need to rebalance.

I would certainly rather be looking at gains across my portfolio, instead of locking in losses to offset gains. But investors must use every tool at their disposal to maximize returns. In this case that may mean taking a loss to minimize the check I have to write to Uncle Sam.

But you may not want to wait until December to do it, because that’s when lots of other investors will be employing the same strategy.

Editor’s Note: Robert Rapier just provided you with invaluable tax advice. In the meantime, if you’re looking for new growth opportunities with less risk, consider the advice of our Investing Daily colleague Jim Pearce. Perhaps you know Jim from his stewardship of our flagship publication, Personal Finance.

Jim Pearce has devised market-beating methodologies in his new trading service, Personal Finance Pro. Want to take investing to the pro level? Learn more here.