Tax Loss Harvesting: Turn Investment Losses Into Tax Savings

Market volatility can be stressful, but savvy investors know how to turn portfolio losses into valuable tax savings through tax loss harvesting. This strategy can significantly reduce your tax burden while improving your portfolio's long-term performance.

What Is Tax Loss Harvesting?

Tax loss harvesting involves selling investments at a loss to offset capital gains from other investments. This strategy allows you to:

• Reduce or eliminate capital gains taxes
• Offset up to $3,000 of ordinary income annually
• Carry forward unused losses to future tax years

How Tax Loss Harvesting Works

Basic Example

Your Investment Activity:

• Sold Stock A for $10,000 gain
• Sold Stock B for $6,000 loss
• Net capital gain: $4,000

Tax Benefit:

• Without harvesting: Pay taxes on $10,000 gain
• With harvesting: Pay taxes on only $4,000 net gain
• Tax savings: Up to $1,500 (assuming 25% tax rate)

Types of Investment Losses You Can Harvest

Short-Term vs. Long-Term Capital Losses

Short-term losses (held ≤ 1 year):

• Offset short-term gains first (taxed as ordinary income)
• Higher tax rates make these losses more valuable

Long-term losses (held > 1 year):

• Offset long-term gains (preferential tax rates)
• Still valuable for reducing overall tax liability

Optimal Offset Strategy

1. Short-term losses offset short-term gains first
2. Long-term losses offset long-term gains first
3. Excess losses offset the other type of gain
4. Remaining losses offset up to $3,000 ordinary income
5. Unused losses carry forward indefinitely

Advanced Tax Loss Harvesting Strategies

1. Direct Indexing

Instead of owning index funds, own individual stocks that mirror an index. This allows you to:

• Harvest losses on individual positions
• Maintain market exposure
• Generate more tax alpha

2. Asset Location Optimization

Place tax-inefficient investments in tax-advantaged accounts:

• Taxable accounts: Tax-efficient index funds, individual stocks
• Tax-deferred accounts: REITs, bonds, actively managed funds

3. Multiple Account Coordination

Coordinate harvesting across:

• Individual taxable accounts
• Joint taxable accounts
• Trust accounts (with proper planning)

The Wash Sale Rule: Critical to Understand

The wash sale rule prevents you from claiming a loss if you buy a "substantially identical" security within 30 days before or after the sale.

What Triggers a Wash Sale?

• Same stock: Selling Apple and buying Apple
• Similar securities: Selling Apple stock and buying Apple options
• Same fund: Selling Vanguard S&P 500 fund and buying it back

How to Avoid Wash Sales

1. Wait 31 days before repurchasing
2. Buy similar but different securities (different S&P 500 fund)
3. Double up: Buy additional shares, wait 31 days, then sell original position

Year-End Tax Loss Harvesting Checklist

November Planning

• Review portfolio for unrealized gains and losses
• Identify harvesting opportunities
• Plan reinvestment strategy to maintain allocation

December Execution

• Execute loss harvesting trades
• Ensure settlement before year-end
• Document wash sale rule compliance
• Reinvest proceeds in similar but different securities

January Follow-up

• Review tax documents for accuracy
• Plan carryforward loss utilization
• Adjust strategy based on new tax year

Common Mistakes to Avoid

1. Violating wash sale rules: Can disallow loss deductions
2. Ignoring transaction costs: Fees can exceed tax benefits
3. Disrupting long-term strategy: Don't let tax tail wag investment dog
4. Missing the 31-day window: Poor timing can trigger wash sales
5. Forgetting about state taxes: Some states don't allow loss deductions

Tax Loss Harvesting in Different Market Conditions

Bear Markets

• Abundant harvesting opportunities
• Focus on maintaining market exposure
• Consider tax-loss harvesting funds

Bull Markets

• Fewer natural opportunities
• Look for sector rotations
• Focus on rebalancing triggers

Volatile Markets

• Regular monitoring creates more opportunities
• Consider systematic harvesting approaches
• Balance trading costs with benefits

Is Tax Loss Harvesting Right for You?

Tax loss harvesting works best for:

• High-income investors in higher tax brackets
• Those with significant taxable investment accounts
• Investors comfortable with active portfolio management
• People with capital gains to offset

Ready to implement tax loss harvesting in your portfolio? Slim Tax's AI advisor can help identify opportunities and optimize your strategy year-round.