tax-loss harvesting

Taxes can take a huge chunk of your clients' investment returns. To help them keep more of what they earn, you need a clear process for using tax-loss harvesting in client portfolios. But there's more to this strategy than knowing the rules. Here's how to apply tax-loss harvesting in your practice.

What is tax-loss harvesting?

Tax-loss harvesting is a tax strategy that lets you sell investments at a loss to offset capital gains elsewhere in a client's portfolio. It allows you to sell investments that are down, replace them with reasonably similar investments, and then offset realized investment gains with those losses.

If capital losses exceed capital gains, you can reduce taxable income by up to $3,000 for the year. Any losses beyond that carry over to future tax years.

For advisors and RIAs, tax-loss harvesting is a direct way to manage clients' after-tax returns. If used consistently, it can lower tax bills, so more of each client's money stays invested.

Tax-loss harvesting rules

The Internal Revenue Service (IRS) sets specific rules that determine when and how you can claim a loss. Tax-loss harvesting rules are strict and getting them wrong means losing the deduction altogether.

Wash-sale rule

Under the wash-sale rule, you're prohibited from claiming a loss if you sell an investment at a loss and then immediately repurchase it. If you buy the same investment or any "substantially identical" investment within 30 days before or after selling it at a loss, the claim will be disallowed.

The wash-sale rule applies to purchases within the same account and any other accounts your client or their spouse controls. This includes tax-deferred accounts like IRAs and 401(k) plans.

Cost basis calculation

Cost basis calculations are important for determining the tax implications of investment transactions. An asset's cost basis is its original value for tax purposes, adjusted for stock splits, dividends, and gains.

If your client holds multiple lots of the same security, cost basis can be calculated two ways:

• average-cost method: uses a per-share average of all purchases to determine the cost basis
• actual-cost method: tracks the actual cost of each specific lot of shares your client holds

For tax-loss harvesting, the actual-cost method has the advantage of letting you designate higher-cost shares to sell, which increases the amount of the realized loss.

State-specific rules

Each state has its own tax laws and regulations, so state rules for tax-loss harvesting can vary. For example, if a state doesn't permit loss carryforwards, tax-loss harvesting could be less beneficial.

Some states, like New Jersey and Pennsylvania, don't allow capital losses to offset ordinary income. Others restrict carryforwards or limit loss deductions altogether. Always check the rules in your client's state before applying this strategy.

Tax-loss harvesting deadline

All transactions must be executed and settled by the end of the calendar year. The deadline for tax-loss harvesting is usually December 31. If that date falls on a weekend, however, the deadline might be the preceding business day. Transaction settlement times can vary, so it's a good idea to complete all trades well in advance of the deadline to make sure they settle in time to be included.

These rules apply across all client accounts, so they need to be part of your review process. Staying on top of them helps you capture the full benefit of the strategy and avoid costly mistakes.

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How tax-loss harvesting works in client portfolios

Tax-loss harvesting lets your clients reduce their taxable investment income by offsetting capital gains with losses. When you sell any asset for a capital gain, you sell another asset for a loss, canceling out some or all taxable gain. It's particularly useful for high-income clients with high capital gains tax rates and for active traders with short-term taxable gains.

After selling at a loss, you reinvest the proceeds in a similar but not identical investment. This keeps your client invested in the market. It's also what separates this strategy from simply timing the market or locking in losses.

Tax-loss harvesting limit example

Here's a straightforward example of how the math can work for your clients. Say you sell two positions this year. Investment A closes at a $30,000 loss, while Investment B generates $25,000 in realized gains. These losses wipe out the entire gain, so your client owes $0 in capital gains taxes.

This still leaves $5,000 in losses to work with. The IRS allows using up to $3,000 of the remaining loss to reduce ordinary income. The extra $2,000 carries over to offset gains or income in future tax years.

The table below breaks down the estimated savings. At a 15 percent long-term capital gains rate and a 35 percent ordinary income tax rate, the total comes to $4,800.

Implications for investments

The IRS has not clearly defined what makes a security "substantially identical," so advisors and their clients have interpreted the wash-sale rule differently.

When choosing a replacement investment, most tax practitioners agree you should consider the degree of holdings overlap and the similarity of prospective returns. The greater the overlap and the more similar the projected returns, the higher the risk of a wash-sale classification. Clients should consult a tax professional before putting this strategy in place.

Here's an illustration of how tax-loss harvesting works in client portfolios.

Applying tax-loss harvesting across a client book takes consistent monitoring and not just a year-end review. The strategy works best when it's part of an ongoing approach to managing after-tax returns.

For more on the regulations shaping how advisors implement strategies like tax-loss harvesting, visit and bookmark our Regulation, Legal & Compliance section.

When should advisors and RIAs use tax-loss harvesting?

Tax-loss harvesting makes the most sense when specific client and market conditions line up. As an advisor, you need to weigh several factors before you act. Here's a short walkthrough of these checks, so you can decide when the trade-off is worth it.

Market conditions

Losses are easier to capture when markets are down or choppy. More positions trade below cost, which creates opportunities to realize losses without abandoning the overall allocation. You can also harvest during normal rebalancing when trimming outperformers and adding to weaker areas.

Tax bracket

Tax-loss harvesting has more impact for clients in higher tax brackets. Offsetting gains and reducing ordinary income delivers larger dollar savings at higher marginal rates. Clients in lower brackets may see limited benefit, so your time may be better used on other tax planning strategies.

Account type

This work belongs in taxable accounts where realized gains are actually taxed. In tax-deferred or tax-free accounts, such as traditional IRAs or Roth IRAs, gains and losses don't create current tax consequences. Focus your effort on brokerage accounts that generate 1099s each year.

Portfolio size

Larger taxable portfolios with recurring gains get the most value from tax-loss harvesting. These clients often own multiple positions with embedded gains and regular turnover. For smaller accounts with low activity, the savings may not justify the trading costs and monitoring time.

Client goals

You also need to check how the strategy fits the client's broader plan. Some clients are comfortable deferring taxes today even if it means recognizing gains later. Others prefer simplicity and fewer trades, even if that leaves some tax savings on the table.

Tax-loss harvesting becomes a standard part of your review cycle when you build it into ongoing tax planning instead of treating it as a year-end scramble. The aim is to reduce lifetime taxes while keeping the portfolio aligned with the client's risk and return targets.

For more insights into this strategy, read our interview with Burton Malkiel on tax-loss harvesting.

How to maximize the benefits of tax-loss harvesting

You get the most value from tax-loss harvesting when it runs off a clear and repeatable process. This process should fit into your existing investment policy, rebalancing, and tax planning work. Here are some practical strategies to maximize the benefit of tax-loss harvesting in client portfolios:

• monitor year-round: build a schedule to scan taxable accounts for harvestable losses throughout the year, instead of only reacting in December
• optimize cost basis: use specific-lot or other flexible cost-basis methods, so you can target high-cost shares and maximize each realized loss
• stay invested while avoiding wash sales: reinvest proceeds in similar but not "substantially identical" holdings, so clients keep market exposure without tripping the 30-day wash-sale window
• pair harvesting with rebalancing: use loss events to trim concentrated or overweight positions and move closer to the target allocation while you lock in usable losses
• plan for future tax brackets: remember that realized losses lower cost basis, so coordinate harvesting with expected tax rates and make a plan for how and when gains will be realized later

These strategies can turn tax-loss harvesting into a steady way to improve after-tax returns. They also keep you focused on lowering clients' lifetime tax bill while still running the right investment strategy for their goals.

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