Tax-Loss Harvesting and Your Portfolio: The Upside of Market Volatility


I doubt if anyone makes an investment, hoping that it will drop in value. After all, the idea is that we invest our money so that, someday, we can live on the proceeds, rather than working for our livelihood.

But sometimes, an investment that didn’t work out — or that hasn’t worked yet — can be utilized to your advantage. Especially when your income places you in a higher tax bracket, it can make sense to recognize a loss in one part of your portfolio to minimize the taxation of gains in another area. This practice is called “tax-loss harvesting,” and recognizing opportunities in this area is an important service that an alert and engaged financial advisor can provide in order to maximize the overall performance of your portfolio and minimize the impact of taxes on your asset base.

What Is Tax-Loss Harvesting?

First, it’s important to remember that in tax-loss harvesting, we are considering two main types of taxes: 1) long-term capital gains tax; and 2) short-term capital gains tax. Long-term capital gains are taxed at one of three rates, depending on your other income: 0%, 15%, or 20%. Especially for higher-income individuals, even the maximum capital-gains tax rate is typically less than the tax rate for ordinary income. Long-term capital gains taxes apply to gains on assets held for a year or more. Gains on assets held for less than a year are subject to the short-term capital gains tax rates, which are the same as the taxpayer’s ordinary income tax rate.

How Does Tax-Loss Harvesting Work?

Suppose you have sold Mutual Fund A, which you owned for over a year, and you realized a capital gain on the sale of $150,000. If you do nothing, you will pay tax on that gain at whatever long-term capital gains tax rate applies to your income bracket (likely either 15% or 20%). However, if you have Mutual Fund B, also held for over a year, which has an unrealized capital loss of $75,000, you might wish to “harvest” that loss and use it to offset the gain in Fund A, cutting in half the amount of your taxable long-term capital gain. That, in its simplest form, is how tax-loss harvesting works.

Often, investors who employ tax-loss harvesting will want to replace the asset that they sold at a loss, in order to maintain their desired asset allocation. But you must wait at least 30 days after a sale before replacing the asset with another that is “substantially identical,” in IRS terminology, in order for the loss to be recognized.

Short-term capital losses may also be used to offset gains, but they must first be allocated against short-term gains, if any. Net short-term losses may then be applied to offset long-term gains. The vice-versa is also true: long-term losses can be used to offset short-term gains, but only after they have been applied to any long-term gains.

Tax-loss harvesting is typically something my clients focus on toward the end of the year, when the picture of gains and losses is becoming clearer. The key is that a qualified, professional financial advisor can help you analyze your portfolio, not only in light of your gains and losses for the year, but also taking into consideration your long-term strategy and needs. Especially for thriving retirees with substantial assets, making tax-efficient use of your holdings is one of the most important things you can do, and I’m here to help.

Stay Diversified, Stay YOUR Course!