Tax-Loss Harvesting Explained: A Guide For Investors

Tax Loss Harvesting Explained

The end of the year is an excellent time to look at tax moves you can make to keep more of your hard-earned money in your pocket. After all, it’s not about what you make, but what you keep over your lifetime - especially when it comes to taxes.

An impactful but often technical strategy for investing and taxes is tax loss harvesting. While it’s important not to let the tax tail wag the dog, it’s helpful to understand this strategy - especially if you have an overly concentrated investment position, substantial income and net worth, a need to reduce capital gains, or a portfolio with large unrealized gains.

Executive Summary

• Year-end is ideal for tax strategies to reduce taxable income and capital gains.

• Tax loss harvesting involves selling investments at a loss to offset gains or income.

• Useful for high earners, concentrated positions, or portfolios with large unrealized gains.

• Requires understanding capital gains rules and wash sale rules.

• Strategy should support long-term investment goals—not just short-term tax savings.

How Capital Gains and Losses Work

Any time you sell an investment, there are tax implications. Whether the sale is taxable depends on whether you sell at a gain or a loss. Your cost basis represents what you paid for the asset. Selling above your cost basis creates a gain; selling below it creates a loss.

Your gains and losses net against each other. For example:

• If you realize a $50,000 gain and a $25,000 loss, you end up with a net gain of $25,000.

• Conversely, if you realize a $50,000 loss and a $25,000 gain, you end with a net loss of $25,000.

At the federal level, there are two types of capital gains:

• Short-term gains: taxed at ordinary income rates

• Long-term gains: taxed at preferential rates, typically lower

The tax rate depends on how long you held the asset:

• Less than one year = short-term rates

• More than one year = long-term rates

Short-term losses offset short-term gains first. Long-term losses offset long-term gains. Any remaining losses can then cross-offset the other type. Losses can apply to gains from stocks, bonds, real estate, crypto, and more.

Tax Loss Harvesting: What It Is

At a basic level, tax loss harvesting involves deliberately selling an investment at a loss to realize that loss.

That realized loss can then be used to:

• Offset capital gains (no dollar limit)

• Reduce ordinary income (up to $3,000 per year)

• Carry unused losses forward indefinitely

  
  

If you have more losses than gains in a given year, you can apply $3,000 toward reducing your taxable income and carry the remaining loss forward to future tax years.

In short: Offset gains - Reduce income - Carry forward leftovers.

Who It May Be Useful To

There are several scenarios where tax loss harvesting can be helpful. Before using this strategy, though, it’s important to consider whether you truly need the loss or if you’re just chasing tax savings. Taxes should support the investment plan - not drive it.

Situations where the strategy may add value include:

Large Unrealized Gains: If you hold appreciated positions with substantial unrealized gains, harvesting losses can help offset the tax impact as you unwind those holdings over time.

High Income or High Tax Bracket: If you’re in a high tax bracket, the $3,000 ordinary income offset can be valuable. Every bit counts when your tax bill is painful.

Overly Concentrated Positions: If you need to diversify a concentrated position, harvesting losses can soften the tax impact of selling appreciated securities and allow you to reallocate more efficiently.

These are just a few examples, but the strategy can apply in many circumstances.

Wash Sale Rule

The wash sale rule applies only when harvesting losses (not gains). It states that if you sell a security at a loss, you cannot repurchase a substantially identical security within 30 days before or after the sale date.

For example, you cannot sell Apple stock for a loss and repurchase Apple stock within that 30-day window.

ETFs and mutual funds offer more flexibility since you can often find similar - but not identical - funds that maintain your allocation. However, two S&P 500 index funds from different providers may still be considered “substantially identical,” depending on how closely they track the same index.

The wash sale rule also applies across:

• Your spouse’s accounts

• Any business or entity you control

• Retirement accounts (in terms of repurchases, not harvesting)

Loss harvesting doesn’t apply inside retirement accounts because those accounts already receive tax advantages.

If you trigger a wash sale, it’s not catastrophic. The loss is disallowed for the current year and instead added to the cost basis of the repurchased security. So if you bought a security at $1,000, sold at a $200 loss, and repurchased within the wash sale window, your new cost basis becomes $1,200.

These rules do not apply when you sell a security for a gain.

Caveats and Helpful Tips

• Replace sold securities with alternatives to maintain your target allocation.

• Reinvest your tax savings - don’t let them sit idle.

• You can harvest losses across your accounts and your spouse’s accounts, even if they’re held at different custodians.

Conclusion

Tax loss harvesting can be a powerful tool, especially for investors with higher incomes, large unrealized gains, or concentrated positions. But like any tax strategy, it should serve your long-term financial plan - not override it.

When used thoughtfully, it can help smooth out tax liabilities, enhance portfolio flexibility, and keep more of your wealth compounding over time.

As with any tax-related decision, it’s wise to coordinate with your financial planner and CPA to ensure the strategy aligns with your goals and overall tax picture.

Key Takeaways

• Capital Gains: Short-term taxed at income rates; long-term taxed at lower rates.

• Tax Loss Harvesting: Offsets gains, reduces income ($3,000/year), or carries forward.

• Who Benefits: High-income earners, concentrated positions, large unrealized gains.

• Wash Sale Rule: Don’t repurchase substantially identical securities within 30 days.

• Tips: Replace with similar securities; reinvest tax savings.

• Reminder: Tax moves should always support long-term goals.