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Posted by Jim McClaflin, EA, NTPI Fellow, CTRC

Everything You Need to Know About Tax-Loss Harvesting

Everything You Need to Know About Tax-Loss Harvesting

Tax-loss harvesting is a strategic technique that savvy investors use to minimize their tax liabilities while optimizing their investment portfolios. By deliberately selling investments that have declined in value, investors can offset capital gains, reduce taxable income, and potentially lower their overall tax bill. In this comprehensive guide, we'll explore the ins and outs of tax-loss harvesting, including its benefits, strategies, rules, and potential pitfalls.

What Is Tax-Loss Harvesting?

Tax-loss harvesting is a tax planning strategy designed to help investors reduce their tax obligations by selling investments that have decreased in value. The key concept is to "harvest" capital losses by selling lost investments and using these losses to offset capital gains or other taxable income. This can lead to lower tax liabilities and an overall more tax-efficient investment strategy.

Benefits of Tax-Loss Harvesting

  • Tax Savings: The primary benefit of tax-loss harvesting is the potential to lower your tax bill. By offsetting capital gains with capital losses, you can reduce the amount of taxable income subject to capital gains tax.

  • Portfolio Optimization: Tax-loss harvesting can be used to rebalance your portfolio. When you sell losing investments, you can reinvest the proceeds into assets that better align with your long-term financial goals.

  • Compound Growth: By minimizing taxes, you can keep more of your investment returns to reinvest, allowing your portfolio to grow faster over time.

  • Risk Management: Tax-loss harvesting allows you to mitigate losses and adjust your portfolio's risk profile. This can be particularly useful during market downturns.

  • Flexibility: You have the flexibility to use harvested losses to offset capital gains in the same year or carry them forward to offset future gains, providing a tax benefit in subsequent years.

How Tax-Loss Harvesting Works

Tax-loss harvesting involves several key steps:

  • Identify Losing Investments: Review your investment portfolio to identify investments that have decreased in value since you acquired them.

  • Sell Losing Investments: Once you've identified the losing investments, you can sell them to realize the capital losses. Be mindful of the "wash-sale rule," which prevents you from repurchasing a substantially identical investment within 30 days before or after the sale.

  • Offset Capital Gains: Use the capital losses from the losing investments to offset any capital gains you've realized in the same tax year. If your losses exceed your gains, you can use the excess losses to offset ordinary income up to a certain limit.

  • Carry Forward Losses: If your capital losses exceed your capital gains and the allowable offset for ordinary income, you can carry forward the remaining losses to offset gains in future tax years, subject to certain limitations.

  • Reinvest or Adjust: After selling the losing investments, you can reinvest the proceeds in new assets that align with your investment strategy, thus maintaining the overall asset allocation in your portfolio.

Tax-Loss Harvesting Strategies

While the basic concept of tax-loss harvesting is straightforward, there are several strategies you can employ to maximize its benefits:

Year-End Tax Planning

Many investors engage in tax-loss harvesting toward the end of the calendar year. This timing allows them to assess their capital gains and losses for the year and make strategic decisions about which investments to sell to minimize their tax liabilities.

ETF and Mutual Fund Swapping

You can replace a losing mutual fund or exchange-traded fund (ETF) with a similar one to maintain your desired asset allocation while realizing capital losses. Ensure the replacement fund is not considered "substantially identical" to the one you sold to comply with the wash-sale rule.

Tax-Efficient Asset Location

Place tax-efficient investments (those with low turnover and tax consequences) in taxable accounts and tax-inefficient investments (those with high turnover and tax consequences) in tax-advantaged accounts like IRAs and 401(k)s. This strategy can minimize taxes over the long term.

Strategic Timing

Consider the timing of your tax-loss harvesting activities. Selling investments during periods of market volatility or in anticipation of changes in tax laws can enhance your tax savings.

Tax-Loss Harvesting Software

Use tax software or tools provided by financial institutions to automate the tax-loss harvesting process. These tools can help you identify suitable opportunities and ensure compliance with tax regulations.

Tax-Loss Harvesting Rules and Regulations

To make the most of tax-loss harvesting, it's crucial to understand the rules and regulations governing this strategy:

  • Limitations on Loss Deductions: The IRS limits the amount of capital losses you can deduct against ordinary income in a single tax year. As of 2021, you can offset up to $3,000 of capital losses against ordinary income ($1,500 for married individuals filing separately). Any remaining losses can be carried forward to future tax years.

  • Netting Capital Gains and Losses: You can offset short-term capital losses against short-term capital gains and long-term capital losses against long-term capital gains. If you have excess losses in one category, you can offset gains in the other category and use any remaining losses to offset ordinary income.

  • Tax Rates: Keep in mind that the tax rates for long-term and short-term capital gains may differ. Understanding these rates is essential for effective tax planning.

  • Tax-Loss Carryforward: Unused capital losses can be carried forward indefinitely to offset capital gains in future tax years. There is no expiration date for these carryforwards.

  • Wash-Sale Rule: The wash-sale rule prevents you from claiming a loss on the sale of a security if you repurchase a substantially identical security within 30 days before or after the sale. If you violate this rule, the loss will be disallowed for tax purposes.

Potential Pitfalls and Considerations

While tax-loss harvesting can be a valuable tool, it's not without potential pitfalls and considerations:

  • Transaction Costs: Frequent trading to implement tax-loss harvesting can lead to increased transaction costs, which may offset some of the tax benefits.

  • Portfolio Disruption: Selling investments to harvest losses may disrupt your portfolio's asset allocation and long-term investment strategy. Be cautious not to make hasty decisions solely for tax purposes.

  • Alternative Minimum Tax (AMT): Tax-loss harvesting can affect your AMT liability, so consider how it may impact your overall tax situation.

  • Future Capital Gains: Keep in mind that by harvesting losses, you may reduce the amount of future capital gains you can offset, potentially resulting in higher taxes down the road.

  • Record-Keeping: Maintain meticulous records of all your capital gains and losses, as well as the timing of your transactions, to accurately report your taxes.


Tax-loss harvesting is a valuable tax planning strategy that can help investors reduce their tax liabilities while optimizing their portfolios. By strategically selling losing investments, investors can offset capital gains, minimize taxable income, and potentially enhance the growth of their investments. However, it's essential to navigate this strategy carefully, considering the rules, regulations, and potential pitfalls. Consulting with a tax professional or financial advisor can be beneficial in developing and executing a tax-loss harvesting strategy that aligns with your financial goals and objectives.



Jim McClaflin, EA, NTPI Fellow, CTRC
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