Tax-loss harvesting explained: Turn investment losses into tax savings
When stocks or bonds decline in value in taxable accounts, you may be able to harvest those losses to offset capital gains elsewhere.
TL;DR
- What it is: Selling investments in a taxable account at a loss to offset taxable gains elsewhere in your portfolio.
- How it helps: Can reduce your tax bill and help position greater long-term growth.
- Who it helps: Investors who sell profitable investments in taxable accounts or want to carry losses forward to future years.
- What to avoid: Violating the Internal Revenue Service’s Wash-Sale Rule (don’t buy a “substantially identical” security within 30 days).
Nobody likes losing money.
That’s where tax-loss harvesting (TLH) can help. When your taxable accounts hands you lemons, you can make lemonade by selling down investments to realize a loss. Those losses can then offset taxable gains from other investments, leaving you with a smaller tax bill and more money where it belongs: in your account.
TLH is often viewed as a down-market strategy, but it can still add value in up markets if you know where to look. In this case, the juice really is worth the squeeze.
Know tax-loss harvesting rules
What is tax-loss harvesting?
Tax-loss harvesting means selling investments in taxable accounts that have dropped in value, then using those realized losses to offset capital gains elsewhere. The goal is reducing the taxes you owe.
What happens when you sell a position that has lost value?
- First, you can use harvested losses to offset capital gains from investments sold at a profit, as well as annual capital gains distributions.
- If your losses are greater than your gains at year end (or if you don’t realize gains at all), you can use up to $3,000 of the losses you harvested to reduce your taxable income (like your salary).
- You can carry forward losses above $3,000 to offset future capital gains and ordinary income over your lifetime
What is the wash-sale rule?
- The Internal Revenue Service’s Wash-Sale Rule prohibits claiming a loss on the sale of an investment if the same or “substantially identical” investment is purchased either 30 days before or after the sale date.
- As they say, you can't have your cake and eat it too. This is the investing equivalent: You can't sell a stock at a loss, rake in the tax savings, and then turn around and buy it back right away.
- A “tax swap” can serve as a placeholder to maintain your exposure to the asset class for 30 days. After 30 days, you can decide whether to switch back to your original holding.
How to use tax swaps
Why use a tax swap?
The goal of a tax swap is to maintain your market exposure for 30 days while playing by the wash-sale rule. But you also can use swaps to reposition portfolios during that 30-day period or longer.
Target new opportunities
Selling one international fund and replacing it with a different international ETF could give you exposure to new markets.
Lower your costs
Replacing higher-fee mutual funds with low-cost core equity and bond ETFs may help you build more cost-efficient portfolios. Expense ratios for State Street® SPDR® Portfolio ETFs are 96% lower than the median US-listed mutual fund.1
Why pay more?
Build your core portfolio for less
Whether you want to generate income, manage risk, or grow capital, you can easily build a diversified core portfolio for less with State Street® SPDR® Portfolio ETFs
Why down markets create tax-loss harvesting opportunities
Naturally, when markets are trending lower, there are far more opportunities to harvest losses.
- Target broad losses. Lots of positions at a loss present an opportunity to sell long-time portfolio winners and harvest losses to offset those gains.
- Reduce taxes on your income. Big losses aren’t fun, but remember when they outweigh your gains, up to $3,000 of the losses can reduce your taxable income.
- Bank losses for the future. Even if you don’t have gains to offset right now, harvested losses roll forward indefinitely—you can apply them in future years.
Why up markets can create tax-loss harvesting opportunities
Contrary to a popular expression, a rising tide doesn’t lift all boats. Inevitably, a couple of seemingly sea-worthy vessels spring a leak. So even when markets are rising, you may find opportunities to harvest losses.
- Zero in on rare underperformers. Certain industries or individual stocks may experience dips even when the market is booming.
- Offset gains from rebalancing. You could realize some gains when you rebalance your portfolio. With TLH, you can help balance the tax impact too.
- Manage mutual fund distributions. If you’ve owned mutual funds long enough, you’ve probably received an unwelcome surprise during tax season: capital gains distributions. Harvesting losses can help cushion the tax blow.
When to harvest losses
Don’t wait until year-end
The time to harvest losses is when they occur. Investments that are down in the spring could bounce back by December. If you wait to harvest, you could miss the window to book losses to offset gains. It’s kind of like picking fruit: grab it when it’s ripe.
To get maximum value from tax-loss harvesting, take a long-term view of the asset and your needs when making decisions and consider:
Loss amount
If a loss is small (i.e., less than $2,000), transaction and tracking costs may eat into any tax savings.
Holding period
The longer you plan to hold the asset, the greater the chance that the tax savings you’ve re-invested will grow.
Legacy plans
If an asset will be left to heirs, there’s less need to measure the value of harvesting a current loss against future taxes due. Because heirs receive a step-up in basis, asset appreciation doesn’t turn into a future tax liability.
When markets hand you lemons, make lemonade
Tax-loss harvesting can help you make the most of losses. Visit our ETF Education Hub to learn other portfolio-boosting strategies.