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Adam Frank

Managing Director, Head of Wealth Planning and Advice, J.P. Morgan Wealth Management

Holding investments through short-term volatility and not trying to time the market is generally prudent, but tax-loss harvesting could enhance your after-tax returns.

As many investors know, not all investments can be outperformers all the time. But there may be a silver lining: Your losses may actually help lower your tax bill thanks to a tax strategy known as tax-loss harvesting.

Of course, you should plan in advance and consult a tax professional to ensure this strategy is a good fit. Here are some considerations:

What is tax-loss harvesting?

Tax-loss harvesting involves selling securities at a loss, or in other words, securities that are currently worth less than what you bought them for. Once you sell these securities, the losses may be able to offset capital gains from other parts of your portfolio. They could also help offset gains from other capital assets you own for which you have realized, or may want to realize, taxable gain.

If done properly, tax-loss harvesting can reduce or eliminate capital gains tax on gains you realize within the same tax year. What’s more, someone with more capital losses than capital gains in a tax year can use up to $3,000 of the unused losses to offset ordinary income and can carry forward unused losses to offset future capital gains.

How tax loss harvesting works

Let's say you invested $1,000 in stock A. Over the course of a month, it loses $400 in value

Identify a loss

A dark-grey-colored rendering of a scale is depicted against a light grey background. The left side of the scale is weighed down by a maroon block with the letter ‘A’ on it in white. The header reads, “Identify a loss,” while the body text reads, “Let’s say you invested $1,000 in stock A. Over the course of a month, it loses $400 in value.

Let's say you invested $1,000 in stock A. Over the course of a month, it loses $400 in value
You sell stock A at $600 and lock in a $400 loss - this is called harvesting the loss. Then, you find a similar, not identical stock, and buy $600 of it.

Harvest the loss and invest in a similar stock

12 blocks, 10 of them colored dark grey, are depicted against a light grey background. A blue depiction of a lock extends above the top middle block, which is maroon with the letter ‘A’ on it in white. A magnifying glass hovers over the right block in row three, which is light green and has the letter ‘B’ on it in white. The header reads, “Harvest the loss and invest in a similar stock,” while the body text reads, “You sell stock A at $600 and lock in a $400 loss – this is called harvesting the loss. Then, you find a similar, not identical stock, and buy $600 of it.”

You sell stock A at $600 and lock in a $400 loss - this is called harvesting the loss. Then, you find a similar, not identical stock, and buy $600 of it.
Use your losses (e.g., $400) to offset capital gains in other parts of your portfolio. This may result in a lower tax bill at the end of the year.

Potentially lower your tax bill

A dark-grey-colored rendering of a scale is depicted against a light grey background. There is a depiction of a woman with dark, shoulder-length hair wearing a white shirt, tan pants, and brown shoes. The left side of the scale holds a maroon block with the letter ‘A’ on it in white. The woman is setting a light green block with the letter ‘B’ on it in white on the right side of the scale. The header reads, “Potentially lower your tax bill,” while the body text reads, “Use your losses (e.g., $400) to offset capital gains in other parts of your portfolio. This may result in a lower tax bill at the end of the year.

Use your losses (e.g., $400) to offset capital gains in other parts of your portfolio. This may result in a lower tax bill at the end of the year.

Beware of “wash sales”

It is possible to repurchase a security you’ve sold.  Just be careful not to trigger a “wash sale,” which will cause your loss to be disallowed in the year it is realized.

Generally speaking, a wash sale occurs when you sell a security at a loss and purchase a “substantially identical” replacement security within 30 days before or 30 days after the sale date.

If you purchase a substantially identical replacement security within this time period, the loss will be disallowed. The disallowed loss is generally added to the tax basis of the replacement security, meaning the loss will be deferred until you sell the replacement. To illustrate, if you sell stock at a loss on December 1, the wash-sale rule could be triggered if you buy a replacement security any time between November 1 and December 31. Special rules may apply in cases where some, but not all, of the shares of the original security are sold. 

What is a replacement security?

A replacement security doesn’t have to be exactly identical to the security you sold to trigger a wash sale. Rather, a replacement security is deemed “substantially identical” to the security it is replacing; in other words, it’s a security so similar to the one being replaced that the IRS doesn’t differentiate between the two. Following this, a wash sale can be triggered if a replacement security is deemed substantially identical. For example, if you sell a stock at a loss, a wash sale can be triggered if you repurchase the same stock, a call option on the same stock or a number of other securities that are similar enough to be considered substantially identical to the sold stock.

To illustrate, if you sell a bond for a loss, the more different your replacement bond is (e.g., maturity date, coupon, etc.), the more likely it is that your loss will be allowed and that the replacement bond won’t trigger a wash sale. Consider consulting with your tax advisor to determine whether a replacement security may be “substantially identical” to the security you sold.

How can you remain exposed to the market without triggering a wash sale?

You can purchase a substitute that isn’t substantially identical to the security you sold. Possible substitutes may be stocks that trade similarly (e.g., you sell a consumer staples stock for a loss and purchase a different consumer staples stock to replace it), or market proxies (e.g., you sell a large-cap U.S. stock for a loss and purchase an index fund or exchange-traded fund that follows the appropriate index), so long as such substitutes are not “substantially identical.”

You can also “double up” (i.e., purchase twice as much) on the security more than 30 days before you intend to sell it – and keep the newly purchased portion – or you can wait for at least 30 days after you sell it to repurchase it. Since doubling up increases your exposure to the security for the period before you sell the loss portion, you need to be sure that this increased concentration makes sense for you.

Note that if any of the replacement securities appreciate in value, and you sell them before you have held them for over a year, any capital gains will be short-term and therefore taxed at ordinary income rates.

Getting started

There are a variety of ways in which tax-loss harvesting can be incorporated into your portfolio, whether you harvest losses on a periodic basis yourself, choose to automate the process, or work with an advisor who can implement the strategy for you. In any case, you’ll want to coordinate with your tax professional to make sure you can benefit from any method that you consider. 

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The impact of a tax loss harvesting strategy depends upon a variety of conditions, including the actual gains and losses incurred on holdings and future tax rates.

Tax loss harvesting may not be appropriate for everyone.  If you do not expect to realize net capital gains this year, have net capital loss carryforwards, are concerned about deviation from your model investment portfolio, and/or are subject to low income tax rates or invest through a tax-deferred account, tax loss harvesting may not be optimal for your account. You should discuss these matters with your investment and tax advisors.


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