What is Tax-Loss Harvesting

This content has been reviewed and edited by an Investment Advisor Representative working for Global Predictions, an SEC-registered Investment Advisor.

We Think You Should Know: Losing money on investments isn’t fun, but it happens to everyone. What really matters is what you do about it. Tax-loss harvesting gives you a way to turn those losses into something useful—like reducing your taxes. And here’s the kicker: it’s not just for the ultra-wealthy or full-time traders. Anyone with a taxable account can likely benefit from this strategy.

In this article, we’ll break down exactly what tax-loss harvesting is, how it works, and why it might be one of the smartest moves you can make with your portfolio.

The Basics: What is Tax-Loss Harvesting?

At its heart, tax-loss harvesting is a strategy that uses your investment losses to offset your gains or reduce your taxable income. Let’s say you sold a winning stock this year and made a nice profit. That’s great—until tax time. The IRS is going to want their share, and that’s where tax-loss harvesting comes in.

Here’s how it works, step by step:

1. Identify Underperforming Investments: Find stocks, ETFs, or other securities in your taxable account that are worth less now than when you bought them.
2. Sell Them to Realize a Loss: Selling “locks in” the loss, making it usable for tax purposes.
3. Offset Your Gains or Income: Apply the loss to your capital gains to reduce how much tax you owe. If your losses are bigger than your gains, you can deduct up to $3,000 from your regular income.
4. Reinvest Strategically: Use the proceeds to buy similar—but not identical—investments, keeping your portfolio balanced and on track.

Practical example: Imagine Sarah, a self-directed investor. She bought a tech ETF for $10,000 that’s now worth $7,000. Normally, she’d just wait and hope it rebounds. But instead, she sells it, harvests the $3,000 loss, and replaces it with a growth-focused ETF. She offsets gains from another sale, cutting her tax bill and staying invested. Smart move, right?

Why Should You Care?

A lot of investors hesitate to sell underperforming investments. They get stuck on the idea of “waiting” for a recovery. But here’s the thing: not every stock or fund is worth waiting for. Sometimes, cutting your losses is the best move—not just for your portfolio, but for your tax bill too.

Tax-loss harvesting lets you:

• Save on Taxes: Keep more of your hard-earned money.
• Optimize Your Portfolio: Move on from underperformers and invest in something with better potential.
• Reinvest for Growth: Put those savings to work, helping your money grow faster over time.

Interesting to read: JP Morgan calculates an additional 1.94% yearly return using monthly continuous tax optimization. Click here to read the full report.

Let’s Make It Practical: A Simple Hypothetical Example

You bought Stock A for $50,000. It’s now worth $40,000. That’s a $10,000 unrealized loss. You also sold Stock B for $45,000, which you bought for $30,000. That’s a $15,000 realized gain.

Normally, you’d owe taxes on that $15,000 gain. At a 15% capital gains tax rate (for example), that’s $2,250. But with tax-loss harvesting, you can use the $10,000 loss to offset part of the gain. If you sold it today, your overall taxable gain is just $5,000, and your tax bill drops to $750. That’s $1,500 saved, just for selling a losing investment strategically.

Here’s the bigger picture: Instead of holding onto Stock A, you could reinvest the proceeds into a similar, but not identical, asset—say, a fund or stock with comparable exposure (sector, country, technologies, growth prospects, etc). This allows you to stay invested while also freeing up that $10,000 loss to improve your tax outcome. Over time, the reinvestment might even outperform Stock A, especially if it had poor prospects to begin with.

Common Behavior: Investors often hold onto losing positions out of emotional attachment or fear of admitting a mistake. But as this example shows, taking action can save money, keep you invested, and position your portfolio for better growth.

When Does Tax-Loss Harvesting Make Sense?

We think tax-loss harvesting works best in the following scenarios:

• You’ve had a good year: If you’ve realized significant gains, harvesting losses can help offset them.
• You’re in a high tax bracket: The more you earn, the higher your marginal capital gains tax rate, the more you stand to save.
• There is significant market volatility: In turbulent markets some of your positions will naturally be up and some down, offering up new tax-loss harvesting opportunities.
• Your portfolio needs rebalancing: Tax-loss harvesting is a great excuse to replace investments that no longer fit your strategy.

Important to know: tax-loss harvesting only works in taxable accounts. It won’t apply to your retirement accounts, like IRAs or 401(k)s.

Avoiding Common Pitfalls

Before you dive in, here are a few things to watch out for:

• The Wash Sale Rule: If you buy back the same or a “substantially identical” security within 30 days before or after selling, the IRS will disqualify your loss. Be careful with this one—it’s a common mistake for new investors. (We explored this rule in detail here to ensure you get it right.)
• Long-Term Goals: Don’t let tax savings derail your overall investment strategy. Always prioritize what’s best for your portfolio in the long run.
• Transaction Costs: If you’re making frequent trades to harvest losses, make sure the savings outweigh the fees.

How to Get Started

If you’re ready to give tax-loss harvesting a try, here’s a simple plan:

1. Review Your Portfolio: Look for investments with unrealized losses that no longer align with your goals.
2. Estimate Your Savings: Use a calculator or tool to figure out how much you could save by offsetting gains.
3. Plan Your Trades: Strategize to avoid unnecessary disruptions to your portfolio.

Practical Tip: Use technology to your advantage. Platforms like PortfolioPilot.com can simplify the process by automatically identifying opportunities for you. With tools like this, you could complete your tax-loss harvesting in less than 10 minutes.

So, keep in mind: tax-loss harvesting is about taking control of your investments and making every dollar work harder for you. Losses happen, but with the right approach, you can turn them into opportunities to save on taxes and accelerate your portfolio’s growth.

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