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Concept · Tax in investing

What is tax-loss harvesting?

Direct answer Selling a position that is below its cost to realize the loss, then buying something similar so market exposure barely changes. The loss offsets capital gains, then up to $3,000 of ordinary income a year, and carries forward. The replacement lot starts at a lower basis, so most of the benefit is a deferral rather than a saving.

The benefit is front-loaded: about 155 basis points in the first year of an account in the standard simulation and near zero after year five unless new cash, recurring short-term gains, or a charitable exit give the losses somewhere to go. It is done with pairs of ETFs in a robo account or stock by stock in a direct-indexing account.

Read loss harvesting, in one example and why the harvesting benefit fades.

Sources

  1. IRS Publication 550, capital lossesirs.gov
  2. AQR, The Tax Benefits of Direct Indexing (2022)aqr.com

Used in

Direct indexing, in one page Own the 500 stocks instead of the fund that owns them. A $1.16 trillion business built on that idea. What you get, what you pay, and who it fits. Eight tax levers, ranked by what they are worth Never selling is worth the whole 35 cents, the one-year line 17, an ETF about 120 basis points a year. Loss harvesting, the lever with the marketing budget, 0 to 30 after year five. Each one, priced. Loss harvesting, in one example Sell a stock at a $10,000 loss, buy a similar one the same day, and the loss cuts this year's tax bill by up to $5,210. What actually happened, step by step, and the catch. Same harvesting, 9 basis points or 115 Retail direct indexing charges 9 basis points a year. Through an adviser and a platform the same logic costs about 115. Against a long-run benefit of 0 to 30, the price decides the sign. The wash-sale rule in four facts Buy back the same stock within 30 days of selling it at a loss and the loss is disallowed. That part is well known. The four facts that catch households are about spouses, IRAs, brokers, and ETFs. Two questions for any tax-savings pitch Does the benefit last past year five? Does the long/short version make sense below $5 million? The published evidence says no to both as general claims. How to ask, and what a good answer sounds like. What an IRA cannot do It cannot borrow, so it cannot short. It destroys a loss harvested next door. And a long-only version of a long/short idea keeps about half the edge. Three limits of the best shelter most people have. Why the harvesting benefit fades after a few years In AQR's simulation harvesting adds 155 basis points in year one and nothing by year five without new cash. Live accounts show the same curve. Why it fades, and the three things that keep it alive.

Related concepts

Cost basisDirect indexingWash-sale rule

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