Tax-loss harvesting sells positions at a loss to offset capital gains and, up to $3,000 a year, ordinary income. Done well, it adds tens of basis points to after-tax returns without changing the household's economic exposure. Done badly, it produces wash-sale violations and small savings at large complexity.
- 01State the wash-sale rule and its consequences.
- 02Design a loss-harvesting workflow that respects the rule.
- 03Estimate the long-term after-tax return benefit of systematic harvesting.
The mechanic
Sell a position at a loss. Use the loss to offset any current-year capital gains. Excess losses offset up to $3,000 of ordinary income. Any remaining loss carries forward to future years indefinitely. Replace the sold position with a substantially non-identical one to keep the household's exposure.
The wash-sale rule
The IRS disallows a loss if the household purchases a substantially identical security within 30 days before or after the sale. The rule applies across accounts, including the household's IRAs. Automated portfolio robots harvest around the rule; households doing it manually should stay well clear of it.
The benefit
Systematic loss harvesting in a taxable account typically adds 20–100 basis points of after-tax return per year, depending on volatility, marginal rate, and portfolio turnover. Compounded over a lifetime, that is material. It is available only in taxable accounts, not tax-advantaged ones.
- Harvest losses; keep exposure with a non-identical replacement.
- Wash-sale rule crosses accounts, including IRAs.
- 20–100 bps a year, in taxable accounts only.