Tax Loss Harvesting: A Guide to Reducing Your Tax Bill
Successful investing isn’t just about making the best investments; it’s also about minimizing your tax liabilities on your capital gains. After all, taxes can often be people’s largest expense in the United States, but with proper planning, they can be reduced. One way to reduce your overall tax burden is through the use of tax loss harvesting, a process that involves selling investments for a loss, in order to “harvest” them for a tax deduction. In this article, we’ll cover everything you need to know about tax loss harvesting and how it might fit into your overall financial strategy!
Understanding the Basics: Capital Gains and Capital Losses
Before we dive into what exactly tax loss harvesting is, it’s important to know the terminology, with the most important terms being “capital gains” and “capital losses”.
Capital gains occur when you sell an investment for more money than you purchased it for (i.e. you generated a profit). Capital gains are taxed at the same rate as ordinary income if you held the investment for less than a year. However, if you hold the investment for longer than a year, any capital gains that you generate are subject to what’s called “long-term” capital gains tax, which varies between 0% and 20% depending on your income. Below is a table that shows the 2025 long-term capital gains tax rates based on tax filing status and income.
|
2025 Long-Term Capital Gains Rates |
|||||
|---|---|---|---|---|---|
|
Maximum Long-Term Capital Gain Tax Rate |
Single |
Married Filing Jointly |
Head of Household |
Married Filing Separately |
Trusts and Estates |
|
0% |
$0 – $48,350 |
$0 – $96,700 |
$0 – $64,750 |
$0 – $48,350 |
$0 – $3,250 |
|
15% |
$48,351 – $533,400 |
$96,701 – $600,050 |
$64,751 – $566,700 |
$48,351 – $300,000 |
$3,251 – $15,900 |
|
20% |
$533,401 or more |
$600,051 or more |
$566,701 or more |
$300,001 or more |
$15,901 or more |
Capital losses occur when you sell an investment for less than you purchased it for. When you implement tax loss harvesting, you use any capital losses that you have (or that you can generate) to help offset, or completely eliminate, the tax burden associated with your capital gains.
What is Tax Loss Harvesting?
Tax loss harvesting is an investment strategy where you sell your investments (typically stocks, mutual funds, or ETFs) at a loss, so the loss becomes “realized”. You can then use these realized losses to offset capital gains that you realized on other investments, helping you reduce your overall tax liability. After harvesting your losses, you can reinvest the proceeds from the asset sale into a similar investment if you would like to maintain exposure to a certain index, sector, or specific business. This makes tax loss harvesting a powerful tool for investors in higher tax brackets and those with significant capital gains.
Another great thing about tax loss harvesting is that you don’t even need to have capital gains in a given year to take advantage of this powerful tool! If your capital losses exceed your gains, you’re able to deduct up to $3,000 of those losses against your ordinary income each year. Additionally, if you have more than $3,000 in net losses in a given year, any losses in excess of $3,000 are carried forward into future years!
How Tax Loss Harvesting Works: A Step-by-Step Process
The tax loss harvesting process follows a logical sequence that, when executed properly, can deliver tax benefits to investors.
Step 1: Review Your Portfolio. Throughout the year, but especially as year-end approaches, examine your taxable investment accounts to identify positions trading below your purchase price. Focus on losses that are large enough to justify the transaction costs and effort involved.
Step 2: Sell Underperforming Investments. Once you’ve identified securities with losses, sell them to realize the capital loss for tax purposes. The loss becomes “real” only when you sell; paper losses don’t count for tax purposes.
Step 3: Offset Your Capital Gains. Use the realized losses to offset any capital gains you’ve recognized during the year. If you sold winning investments earlier in the year, these harvested losses can reduce or eliminate the taxes owed on those gains.
Step 4: Deduct Against Ordinary Income. If your losses exceed your gains, deduct up to $3,000 of the excess against your ordinary income, which is taxed at higher rates than long-term capital gains.
Step 5: Carry Forward Remaining Losses. Any losses beyond what you’ve used carry forward to future tax years indefinitely, providing a tax asset you can use whenever you have future gains or in $3,000 annual increments.
Step 6: Reinvest the Proceeds. To maintain your desired asset allocation and market exposure, reinvest the proceeds from your sale into similar, but not substantially identical, securities. This keeps you invested while capturing the tax benefit.
What are the Benefits of Tax Loss Harvesting?
There are several benefits of tax loss harvesting, with the most prominent one being the fact that you can save money on your tax bill each year. If you are in the 37% federal tax bracket and harvest $10,000 in capital losses to offset short-term capital gains in other investments, that saves you from paying $3,700 in federal taxes (and potentially some state taxes, if your state allows for the deduction of capital losses).
There are also quite a few positive side effects of regular tax-loss harvesting, too. The first of which is that regular tax loss harvesting, if implemented properly, can help increase your after-tax investment returns marginally. Even if you are able to increase your after-tax returns by just 0.25% annually through the use of tax-loss harvesting, that quarter point can compound considerably over the course of decades!
Additionally, even if you aren’t able to fully take advantage of your capital losses every year, you can still build up a “tax loss bank” over time. You can then draw on these capital losses in the future when you have a considerable amount of capital gains you need to offset.
Lastly, a quarterly or even annual review of your finances and tax loss harvesting opportunities with a trusted financial advisor provides you with ample opportunities to adjust your strategy and rebalance your portfolio. This helps you ensure that your portfolio is exactly where it needs to be, and that it stays on the right trajectory!
What is the Wash Sale Rule?
The most crucial regulation for tax loss harvesting is the wash-sale rule. This is an IRS rule that disallows investors from claiming a tax loss on a security if they purchase a “substantially identical” security within 30 days before or after the sale. If you violate this rule, you don’t lose the loss that you’ve generated forever. Instead, the loss from the wash sale is added to the cost basis of the replacement security. You are then allowed to realize the loss when you eventually sell the replacement security.
Although “substantially identical” may seem straightforward, it’s a bit more ambiguous than you might guess. Selling Visa (V) at a loss and purchasing Mastercard (MA) is allowed, as these companies aren’t considered to be “substantially identical”. However, the lines become more blurred when trying to harvest losses generated through ETFs. For example, selling one S&P 500 ETF to buy a different S&P 500 ETF that tracks the same index is generally considered risky from a wash sale perspective, as many tax professionals would view these funds as substantially identical despite different ticker symbols. If you’re looking to do tax loss harvesting with ETFs, it’s probably best to consult a financial professional who can help you navigate these nuances and ensure you’re staying compliant with IRS rules.
Implementing Tax Loss Harvesting Into Your Investment Strategy
As you can tell after reading this article, tax loss harvesting is a potent tool for high income earners, but it can become complex, very quickly. That’s why it’s often best to work with a financial professional year-round. Frantically selling losing investments in December might work in the short term, but it’s not a viable strategy for the long term.
At Stansberry Asset Management, we won’t just help you with tax loss harvesting, we work together with you to develop a holistic financial plan that’s tailored to your own unique situation and goals.
Schedule a complimentary consultation with Stansberry Asset Management (SAM), today to discuss how tax loss harvesting could help reduce your tax liabilities while staying in line with your overall financial strategy.
This material is for informational purposes only and is not intended to provide, and should not be relied upon for, tax, legal, or accounting advice. SAM does not provide tax advice. Clients and readers should consult their accountant or qualified tax professional regarding their specific tax situation.
