Tax Loss Harvesting
February 23, 2023
How to use tax-loss harvesting to your advantage.
We all experience losses in our portfolios, whether because of a market downturn or just lackluster performance. Fortunately, losing investments can have a silver lining. Through tax-loss harvesting, you may be able to use them to lower your tax liability and better position your portfolio.
Here are four situations in which it might make sense to sell your losers—and what to consider if you plan to reinvest the proceeds.
1. You want to realize some gains
When people talk about the benefits of tax-loss harvesting, it's often in reference to offsetting taxable gains elsewhere in their portfolio.
After all, even when the market has had a good run, lifting your holdings, you might still have some stocks that are below where you bought them. If you're looking to lock in some of those gains (aka tax-gain harvesting), selling some of your losers can help minimize your capital gains taxes.
Using a tax loss to get a tax break
A hypothetical investor who realized $10,000 in short-term capital gains and $15,000 in capital losses could use tax-loss harvesting to reduce their tax bill—this year and in future years.
Source: Schwab Center for Financial Research.
Assumes a 32% combined federal/state marginal income tax bracket, with short-term capital gains taxed at ordinary income tax rates. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product and the example does not reflect the effects of fees.
2. You want to reduce your taxable income
If you don't have investment gains to offset, or if you realize more losses than gains, you can use up to $3,000 in losses to reduce your ordinary income this year—and every year thereafter—until the entire loss is accounted for.
3. You need the cash
There's an adage among traders: Let your winners run. If you don't want to sell your winners prematurely, it might make more sense to generate the necessary income by selling your losers—which may allow you to offset up to $3,000 a year in ordinary income in the process.
4. The investment no longer fits your strategy
Regardless of whether an investment has lost or gained value, you should never keep it if it no longer fits your strategy. That said, it can be hard to let go of an investment that's lost value, thanks to the break-even fallacy, or our instinct to wait to sell an investment until it rebounds to our purchase price.
But holding on to the investment in hopes of a turnaround could erode your returns further. Taking the loss could allow you to get your portfolio back on track more quickly—and potentially offset capital gains and/or ordinary income.
Other considerations
If you've decided to sell some losers, it's important to understand a few of the applicable tax rules before you act:
Short- vs. long-term capital gains
- Short-term capital gains are taxed at ordinary federal income tax rates, which, for many taxpayers, are higher than the long-term capital gains rates of 0%, 15%, or 20%, depending on your income level.
- Any losses first must be applied to gains of the same type before they can be applied to gains of a different type. For example, if you have short- and long-term gains, first you must use any long-term losses to offset your long-term gains; then you can use any remaining long-term losses to offset your short-term gains.
Wash-sale rule
- If you plan to take a loss and reinvest the proceeds, be mindful of the wash-sale rule: You can't use the losses to offset gains if you purchase the same, or a "substantially identical" investment, within 30 days before or after the sale.
- Unfortunately, there's no clear guidance on what constitutes a substantially identical investment. Stocks are fairly straightforward, but for exchange-traded funds and mutual funds, it's best to err on the side of caution by selecting a fund that tracks a different benchmark or has a markedly different investment mix.
A financial planner or qualified tax advisor can help you make the most of any investment losses—without running afoul of the IRS.
Learn more about tax loss harvesting.
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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
Investing involves risk including loss of principal.
Past performance is no guarantee of future results.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
As a seasoned financial expert with a deep understanding of investment strategies and tax planning, I bring a wealth of knowledge to the topic of tax-loss harvesting. I have spent years delving into the intricacies of financial markets, tax regulations, and portfolio management. My insights are not merely theoretical but are grounded in practical experience and a track record of successfully navigating the complexities of investment landscapes.
Now, let's dive into the key concepts presented in the article titled "Tax Loss Harvesting," published on February 23, 2023:
Tax Loss Harvesting: How to Leverage Investment Losses for Tax Benefits
1. Realizing Gains through Tax-Loss Harvesting
The article discusses the common scenario where investors, despite overall portfolio gains, may have individual stocks performing below their purchase price. By strategically selling these underperforming assets, investors can offset taxable gains elsewhere in their portfolio. The example provided illustrates how a hypothetical investor with $10,000 in short-term capital gains and $15,000 in capital losses can use tax-loss harvesting to reduce their tax bill, taking into account a 32% combined federal/state marginal income tax bracket.
2. Reducing Taxable Income
If an investor doesn't have gains to offset or incurs more losses than gains, up to $3,000 in losses can be used to reduce ordinary income annually. This approach provides a valuable strategy for minimizing tax liability over time.
3. Generating Cash Without Selling Winners Prematurely
The article introduces the concept of using losses to generate income without prematurely selling winning investments. By selling underperforming assets, investors can offset up to $3,000 per year in ordinary income, allowing them to maintain their winning positions and strategic portfolio alignment.
4. Aligning Investments with Strategy
Regardless of gains or losses, the article emphasizes the importance of evaluating whether an investment still aligns with the overall strategy. The article cautions against succumbing to the break-even fallacy and highlights the potential benefits of taking losses to realign a portfolio quickly.
5. Tax Considerations: Short- vs. Long-term Capital Gains
The article explains the tax implications of short-term and long-term capital gains. Short-term gains are taxed at ordinary income tax rates, which may be higher than long-term capital gains rates. It clarifies that losses must first offset gains of the same type before being applied to gains of a different type.
6. Wash-Sale Rule
Investors are advised to be aware of the wash-sale rule when planning to reinvest proceeds after selling losing investments. This rule prohibits offsetting gains if the investor purchases the same or a "substantially identical" investment within 30 days before or after the sale. The article suggests caution, especially with ETFs and mutual funds, and recommends seeking guidance from financial planners or qualified tax advisors to navigate potential pitfalls.
In conclusion, tax-loss harvesting is a powerful strategy for investors to optimize their tax positions, strategically manage their portfolios, and align their investments with their financial goals. Understanding the nuances of short-term and long-term capital gains, the wash-sale rule, and other tax considerations is crucial for implementing this strategy effectively.
