Tax-loss harvesting is the most efficient way for investors to offset capital gains . An ETF gives investors the control to manage their taxable gains while keeping fees low.

Investors are beginning to prepare for the worst as Bush tax cuts are expected to expire in January 2013. As the United States could be edging toward a fiscal cliff, offsetting tax losses is more important than ever for capital preservation. However, much of the outcome of the tax cut expirations are dependent upon who takes the White House and what Congress will decide until then. [Taxes and ETFs: It’s Not What You Pay, It’s What You Keep]

With no congressional action, the top ordinary income tax rates are set to rise to as high as 40%, from 35%, for the nation’s top earners. In addition, if the 15% tax rate for qualified dividends expires, they will be taxed as ordinary income. The 15% rate on capital gains is scheduled to rise to a high of 23.8%, plus a 3.8% Medicare surcharge on investment income for high earners. [Dividend ETFs,the Fiscal Cliff and Potential Tax Hikes]

Tax loss harvesting is selling stocks or an ETF at a loss to help offset any capital gains tax liability. Thus, recognition of short term capital gains, which are taxed at a higher rate, will be limited. This can help limit the amount an investor will owe and can preserve capital in the end. [Dividend ETFs May Lose Appeal if tax Cuts Expire]

In an ideal situation, some capital gains that are offset by large losses can be carried forward and booked against total income. In order to do a carry-forward, the wash-sale rule must be adhered to – the investor can not try to buy the same investment 30 days before or after the sale is made.

However, an investor can park their capital into a similar ETF or stock instead. A fund that is the same size, has the same bid/ask spread or price is alright, and something from the same sector or corner of the market, reports Ari Weinberg for Forbes.

Tisha Guerrero contributed to this article. 

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.