Tax loss harvesting 101

August 1, 2023

I know some advisors who keep this chart in their office as a reminder of the market's resilience.

But as tough as a down market is, there are some opportunities you can take advantage of.

And one of them is tax loss harvesting.

Tax loss harvesting is the act of selling one security at a loss and replacing it with a similar (but not substantially identical) security.

What does that confusing sentence mean?

It means you get to take the loss today while staying invested in the market.

Why would you want to take a loss?

Because losses have tax benefits:

1) You can use losses to offset capital gains.

If you have a fund in your account that's worth more than what you bought it for (aka a gain), you can use your loss to offset some or all of your gain.

It depends on how big your gain or your loss is.

2) You can use losses to offset your ordinary income.

You can offset an unlimited amount of gains, but you can only use $3,000 of your loss against your taxable income.

So, if you sell a fund with a loss of $20,000.

This is how you could use it for the tax benefits:

That’s right.

If you don’t use the entire loss, you can carry it forward indefinitely to use in future years.

A few critical things to know:

1) This will only work in taxable accounts (like individual & joint brokerage).

This strategy won’t work in tax-deferred accounts like your 401(k) or Roth IRA.

2) This isn’t a market timing rule.

The idea isn’t to sell out and sit in cash.

It’s to sell the fund and buy another one in the same asset class, so you stay invested.

3) You have to be careful of the "wash sale" rule.

If you replace the security with one that the IRS deems too similar, the loss will be a wash and you won’t be able to use it for tax purposes.

Tax-loss harvesting is not for everyone.

There are cases where harvesting losses will not benefit you.

And if you aren’t careful, you could disrupt your investment strategy.

It’s important you talk to your accountant or financial professional before using this strategy.

If you want to read more about it, check out this article I was quoted in: