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Understanding Tax-Loss Harvesting

Tax-loss harvesting involves intentionally taking a loss on investment sales to offset your tax bill. Many investors capitalize on this strategy in December when reviewing their portfolio’s annual performance. While tax-loss harvesting doesn’t fully recover your spent capital, it can lessen the severity of your losses. 

🤔 Understanding tax-loss harvesting

The IRS requires investors to pay capital gains on any net profits incurred from portfolio trades in a given calendar year. But if you have investments that have declined, rather than gained, you can “harvest” these losses by selling the losing securities. Then, you can write off the losses against your gains to lower your tax bill. 

Generally, investors use tax-loss harvesting to offset profits on short-term gains, which are taxed at higher rates than long-term gains. That said, you can also use long-term losses to offset long-term gains. 

However, if you incur a net loss or haven’t realized any gains, you can still benefit from selling losing assets. Every year, the IRS lets you write off up to $3,000 in net losses against your ordinary income. And if you suffer larger losses, you can “carry forward” your balance to lower future tax bills.   

What this means for you

Tax-loss harvesting can be a useful strategy to lower your annual tax bill. However, it’s not always a wise decision—and there are some limitations to its uses. 

Tax losses don’t apply to tax-deferred accounts

Tax-loss harvesting is designed to reduce your losses in taxable accounts. This makes it less useful for retirement investors who primarily save in tax-deferred accounts like IRAs or 401(k)s.  

It’s most beneficial for higher earners

Tax-loss harvesting lowers your current tax bill, meaning it’s most beneficial for those in higher tax brackets. For instance, if you’re in the 10% tax bracket, you’d only save $300 on $3,000 in losses. But if you’re in the 30% tax bracket, you’d see tax savings of $900 on the same losses.  

Beware the wash-sale rule

Perhaps the most common snafu in tax-loss harvesting is the wash sale rule. Essentially, this rule dictates that if you sell an asset at a loss and buy a “substantially identical” asset within 30 days, you lose your tax write-off. “Substantially identical” securities include those issued by the same company, convertible bonds and derivatives based on the same security. 

Unfortunately, since wash-sale transactions can’t be used to offset capital gains, you can’t harvest losses and buy the same security at a discount at the same time. However, the rule generally doesn’t apply to other securities within the same industry or similar but non-identical mutual funds and ETFs. 

In short: Harvesting investment losses can help you save on your tax bill—but you shouldn’t sell losers only for the tax benefits. Instead, consider pairing your tax-loss strategy with pre-planned activities, such as portfolio rebalancing. 

You should also consider the impacts of when you harvest losses. While many investors wait until December, selling during a down market throughout the year can put capital in your pocket to buy other higher-quality assets at a discount. Aside from the immediate tax benefits, you may see greater long-term profits as your new assets (hopefully) appreciate over time. 

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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