Tax-Loss Harvesting: Using Market Declines to Your Advantage

Tax-loss harvesting is a strategy that involves selling investments that have declined in value to realize a capital loss. These losses can offset capital gains (or up to $3,000 of ordinary income per year), potentially reducing your tax liability.

How Tax-Loss Harvesting Works

When you sell an investment at a loss in a taxable account, you can use that loss to offset capital gains realized elsewhere in your portfolio. If your losses exceed your gains, you can deduct up to $3,000 ($1,500 if married filing separately) against ordinary income in the current year. Any remaining losses can be carried forward to future tax years indefinitely.

The Wash Sale Rule

The IRS wash sale rule prevents you from claiming a loss if you purchase a "substantially identical" security within 30 days before or after the sale. This means you cannot sell an investment at a loss and immediately buy it back. The loss is disallowed, and the cost basis is adjusted to include the disallowed loss.

Some investors maintain a list of similar-but-not-identical holdings (for example, different S&P 500 index funds from different providers) to avoid triggering the wash sale rule while maintaining similar market exposure.

Practical Considerations

• **Rebalancing opportunity:** Tax-loss harvesting can be combined with portfolio rebalancing to maintain your target asset allocation.
• **Year-end focus:** Many investors evaluate opportunities in November and December, but harvesting can happen throughout the year.
• **State taxes:** Capital losses may also offset gains at the state level, depending on your state's tax rules.
• **Record keeping:** Keep detailed records of all transactions, cost basis, and realized losses for tax reporting.

What This Strategy Cannot Do

Tax-loss harvesting is not appropriate for tax-advantaged accounts like IRAs and 401(k)s, where gains and losses are not taxable. It also does not eliminate taxes -- it defers them by reducing your cost basis when you reinvest. Additionally, frequent trading may trigger transaction costs and administrative complexity.

Questions to Discuss with Your Advisor

• Does your portfolio have unrealized losses that could be harvested?
• How does tax-loss harvesting fit with your overall tax strategy?
• What are your transaction costs and how do they compare to potential tax savings?
• How can you avoid triggering the wash sale rule while maintaining your investment strategy?

---

**Disclosure:** This is educational information only and is not investment or tax advice. The rules surrounding capital losses, wash sales, and tax reporting are complex. Consult a qualified tax advisor and financial advisor before implementing any tax-loss harvesting strategy.