Tax Loss Harvesting

Tax-Loss Harvesting

What is tax-loss harvesting?

Tax-loss harvesting is the practice of selling investments that have declined in value to realize a capital loss, and using that loss to offset capital gains from profitable investments. The goal is to reduce current tax liability while preserving the portfolio’s overall risk/return profile.

Key points

• Realized capital losses offset realized capital gains. Reducing gains lowers the tax owed.
• Short-term losses first offset short-term gains; long-term losses first offset long-term gains. Net losses of either type can then offset the other.
• If net capital losses exceed capital gains, an individual can deduct up to $3,000 per year ($1,500 if married filing separately) against ordinary income. Excess losses can be carried forward to future years.
• Avoid buying a “substantially identical” security within 30 days before or after the loss sale (wash-sale rule), or the loss is disallowed for tax purposes.

How it works

1. Identify investments with unrealized losses.
2. Sell those positions to realize capital losses.
3. Use losses to offset realized gains realized during the year (or up to $3,000 against ordinary income).
4. Re-establish equivalent market exposure by buying a similar—but not substantially identical—security to maintain asset allocation and intended risk exposure.

Most investors perform harvesting near year‑end, after reviewing realized gains and losses for the year.

The wash-sale rule

The wash-sale rule disallows a loss deduction if you buy the same or a substantially identical security within 30 days before or after the loss sale (a 61‑day window including the sale date). Common workarounds:
* Buy a different ETF or mutual fund that tracks the same index but is issued by a different provider.
* Wait 31 days to repurchase the original security.
Note: “Substantially identical” is not rigidly defined in all cases; when in doubt, consult a tax professional.

Example

Assume an investor has these realized gains and available losses:
* Realized gains: long‑term gain $200,000 (taxed at 20%), short‑term gain $150,000 (taxed at 37%).
* Available losses to harvest: long‑term loss $130,000, short‑term loss $100,000.

Without harvesting:
* Tax = ($200,000 × 20%) + ($150,000 × 37%) = $40,000 + $55,500 = $95,500.

With harvesting (apply like‑term losses first):
* Long‑term: ($200,000 − $130,000) × 20% = $14,000.
* Short‑term: ($150,000 − $100,000) × 37% = $18,500.
* Tax = $14,000 + $18,500 = $32,500.

Harvesting in this example reduces tax by $63,000.

Maintaining portfolio balance

Selling a losing position changes your asset allocation. To preserve your intended exposure:
* Buy a similar but not substantially identical security (e.g., a different ETF tracking the same index) immediately.
* Rebalance afterward to restore target allocations.
* Track holding periods if you want future gains to benefit from long‑term capital gains rates.

Practical considerations and tips

• Netting order matters: short‑term losses offset short‑term gains first (short‑term gains are taxed at higher ordinary rates).
• Keep good records of purchase and sale dates and amounts to support tax filing.
• Frequent harvesting can generate lots of transactions and wash-sale complexities—automated tools or advisor services can help.
• Harvesting is most useful when you have realized gains to offset or when you expect to be in the same or higher tax bracket.
• Be mindful of transaction costs, bid‑ask spreads, and the potential for deviating from your intended investment strategy.

Bottom line

Tax-loss harvesting can reduce your tax bill by using realized investment losses to offset gains and, to a limited extent, ordinary income. It can preserve portfolio exposure if executed carefully, but the wash-sale rule and recordkeeping are important constraints. Consider tax consequences, transaction costs, and whether professional advice or automated tools are appropriate for your situation.