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    How to Tax Loss Harvest

    Educational content only. This article is for informational purposes and does not constitute personalized financial, tax, or investment advice. Consult a qualified professional for guidance specific to your situation.

    TL;DR

    • Delays taxes, doesn't eliminate: Your cost basis resets lower after harvesting, so you'll owe more later when you sell
    • Easy to DIY: Sell the losing fund, immediately buy a similar-but-different one — and respect the 30-day wash sale rule
    • Not worth paying for: Robo-advisor management fees eat what you save; do it yourself during market dips if at all

    Tax loss harvesting is a strategy that you can use to reduce your tax liability. Robo-advisors use it as one of their biggest selling points, and I don't think it's worth it for several reasons*:

    • Your ability to tax loss harvest is limited—the market usually trades at all-time highs
    • Tax loss harvesting delays taxes instead of eliminating them
    • The robo-advisor management fee will eat away what you save pretty quickly

    Also, it's easy to DIY.

    * Unless you're in a very high marginal tax bracket that's meaningfully higher than your long-term capital gains tax, though it's still not worth paying for.

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    What is tax loss harvesting?

    Tax loss harvesting involves selling an investment that you've purchased at a loss and using the proceeds from the sale to purchase a "similar" investment. The IRS then allows you to deduct the loss from your income in the present tax year (up to a maximum of $3K). However, because the new purchase is resetting your cost basis, tax loss harvesting is a strategy that delays taxes, not one that eliminates taxes.

    Example: Tax Loss Harvesting in Action

    • January 2020: You invest $10K into VTI. In 3 months, US markets plummet 30%.
    • VTI is now worth $7K, so you sell it at a loss of $3K. But you immediatelly buy SCHB for $7K, a similar ETF.
    • Tax benefit: You get to write-off $3,000 from your 2020 taxes, which means it probably saved between $300-600.
    • By March 2024, your $7K SCHB investment has grown to $14K and you want to sell. The catch: Your cost basis is now $7K (not your original $10K).
    • You now owe long-term capital gains tax on the full $7K profit. This means you're paying tax on the $3K loss you previously harvested.
    • At a typical 15% long-term capital gains rate, that's an extra $450 in taxes
    • Bottom line: Depending on your tax brackets then vs. now, this could cost you more money in the long run

    Important Consideration

    Remember that tax loss harvesting doesn't eliminate taxes—it only defers them. The benefit comes from the time value of money and potentially taking advantage of different tax rates at different times in your life.

    How do I DIY tax loss harvesting?

    Step-by-Step Guide

    The White Coat Investor has great step-by-step instructions on how to tax loss harvest. Their guide covers the specific actions to take, timing considerations, and how to avoid the wash sale rule.

    Read the detailed guide on White Coat Investor

    Key Tips for Successful Tax Loss Harvesting

    • • Be aware of the wash sale rule (don't buy a "substantially identical" security within 30 days before or after the sale)
    • • Choose replacement funds that are similar but track different indexes
    • • Consider transaction costs and expense ratios when selecting replacement investments
    • • Keep good records of all transactions for tax reporting
    • • Remember that the strategy is most beneficial during market downturns

    Summary: Is Tax Loss Harvesting Worth It?

    While tax loss harvesting can provide short-term tax benefits, it's important to consider:

    • Opportunities for tax loss harvesting are limited since markets typically trend upward
    • The strategy only defers taxes rather than eliminating them
    • Management fees from robo-advisors offering this service often outweigh the benefits
    • DIY tax loss harvesting is relatively simple and can be done without paying advisor fees

    Bottom line: Tax loss harvesting can be worth doing yourself during market downturns, but probably isn't worth paying a management fee for, especially if you're not in a high tax bracket.

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