Tips for Tax-Loss Harvesting

Cathy Lee, CFP®

Tax Associate

This week’s reader question: What is the best way to think about tax-loss harvesting—what are your thoughts on timing and best practices?

Cathy Lee, Tax Associate, had this to say:

Tax-loss harvesting—selling a losing investment to reduce your tax obligations—can help minimize taxes by offsetting capital gains and up to $3,000 in ordinary income each year for individuals. Any unused losses (for example, if you didn’t realize any gains or reach the $3,000 limit in ordinary income) can be carried over and spread across several tax years.

But remember: Tax-loss harvesting is only effective when it’s applied properly and strategically.

The first guardrail to keep in mind is the “wash-sale” rule, designed to deter the sale of securities simply for tax avoidance. In sum, you can’t sell an investment for a loss and have purchased the same holding or one that is “substantially similar” within 30 days before or after the loss. For instance, if you sell your position in, say, Vanguard’s S&P 500 Index fund, you can’t obtain the tax benefit of the loss if you purchased Vanguard’s S&P 500 ETFA type of security which allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. in the 30 days before or after the sale.

Next, tax-loss harvesting doesn’t necessarily come into play at the end of the calendar year or during tax season. Instead, it’s most useful when conditions are right. For instance, you’re more likely to experience losses when volatilityA measure of how large the changes in an asset’s price are. The more volatile an asset, the more likely that its price will experience sharp rises and steep drops over time. The more volatile an asset is, the riskier it is to invest in. causes ongoing market swings. The other opportune time to think about tax-loss harvesting is when you are rebalancing your portfolio. If you are planning to trim a position to tune up your asset mix or change your riskThe probability that an investment will decline in value in the short term, along with the magnitude of that decline. Stocks are often considered riskier than bonds because they have a higher probability of losing money, and they tend to lose more than bonds when they do decline. exposure, it may also be a good time to look for a tax upside.

Oh, and tax-loss harvesting only applies to your taxable accounts, so it’s not relevant to your 401(k), IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. or other retirement accounts.

All of this adds up to one key takeaway: Tax-loss harvesting is something to consider in support of your long-term investment strategy. Reserve your trades for when they will benefit your overall portfolio and financial goals—saving on taxes is icing on the cake.

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