Introduction to Tax-Loss Harvesting

Some investors may be looking for ways to manage their potential investment-related losses and tax obligations. If this describes you, tax-loss harvesting might be a strategy worth considering. However, executing it can be challenging and should not be attempted without consulting a tax professional. The savings provided by tax-loss harvesting may depend on your tax bracket and investment allocation, among other considerations.

To help you understand tax-loss harvesting, here’s a basic primer about what it is and how it works.

What is Tax-Loss Harvesting?

Tax-loss harvesting means deliberately selling investments at a loss to offset gains from other investments, potentially reducing your tax bill.

In other words, if an investment has lost value, you can sell it and use the loss to offset gains you realize elsewhere. That lowers your taxable income for the year, which may result in tax savings.

This discussion applies to investments bought and sold within taxable accounts; losses inside traditional IRAs and 401(k)s do not create a capital-loss deduction on your individual return. Even without realized capital gains, an allowable net capital loss may reduce ordinary income within the applicable annual limit.

Capital losses first offset capital gains; if losses exceed gains, the deduction against other income is generally limited to $3,000 a year ($1,500 if married filing separately), with unused losses potentially carried forward.

What Might Tax-Loss Harvesting Look Like?

First, a rule to know: losses offset gains of the same type first. Short-term losses (on assets held a year or less) offset short-term gains, and long-term losses offset long-term gains. Any net loss left over can then offset gains of the other type.

Hypothetical example: assume you are not married filing separately, have no other capital transactions or carryforwards, and no wash-sale adjustment applies. Less than a year ago, you bought one stock that has since gained $10,000 and another that has lost $15,000. You sell both, for a net short-term loss of $5,000.

In this simplified example, the $15,000 loss offsets the $10,000 gain, leaving a $5,000 net loss. Assuming the deduction and carryover rules permit it, $3,000 reduces ordinary income and $2,000 carries forward. For married taxpayers filing separately, the ordinary-income deduction limit is $1,500 rather than $3,000.

These amounts reduce taxable income, not the tax bill dollar for dollar. Under the hypothetical assumption that the full $3,000 deduction offsets income taxed at 24%, the associated federal income-tax reduction is $720. This is arithmetic, not an estimate of any client's outcome, and excludes other taxes, costs and future tax effects.

Tax-loss harvesting can be a complicated tactic with many moving parts; it may require you to consult with a financial professional beforehand, and it won’t be an effective strategy for every investor in all situations.

Key Considerations for Tax-Loss Harvesting

Loss opportunities can arise during the year, but trading decisions also need to consider risk, costs and your broader tax circumstances. Harvesting more losses does not necessarily produce a better after-tax outcome.

After harvesting, consider replacing what you sold with investments that fit your goals and the rest of your portfolio. Those replacements must meet certain requirements, though.

Under the IRS wash-sale rule, a loss can be disallowed if substantially identical securities are purchased within 30 days before or after the sale. Certain spouse and IRA purchases can also matter. The managed account alone may not reveal every relevant transaction; discuss outside holdings and trading with your adviser and tax preparer.

Tax-loss harvesting operates on the basic idea that a dollar is worth more today than it will be in the future since that dollar can be invested and has the potential to grow before your tax bill comes due. While effective tax-loss harvesting can bear fruit over time – or at least help mitigate losses – it’s still a strategy that requires careful planning.

Sometimes, it may not be worth selling an asset to earn the associated tax deduction. Your decision to sell depreciated assets (and harvest their losses) will likely be part of a broader portfolio adjustment or reallocation strategy.

Could Tax-Loss Harvesting Make Sense for You?

By leveraging tax-loss harvesting as another tool within your financial toolbox, you may be able to lower your total tax burden and make tax-efficient adjustments to your investment strategy over time. However, it’s not a tool that should be used lightly – the process can be complex and may not result in savings if improperly handled.

Active tax management is optional for enrolled taxable assets in Personal Index Portfolios. Altruist, our custodian, charges up to 0.10% per year on enrolled assets, separate from IFP's advisory fee; Integrity Financial Planning receives no part of it. Review the complete fees.

For clients with assets under management under $500,000, the Advisor reserves the right to charge an hourly fee for financial planning.

Schedule a free, no-obligation introductory meeting with Todd to discuss whether the approach fits your situation. Harvesting may defer rather than eliminate tax and does not guarantee savings or higher returns.

This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.

Endnotes

IRS Publication 550, Investment Income and Expenses, including capital-loss deduction and wash-sale rules.