Tax-loss harvesting can help investors potentially lower tax bills and enhance long-term portfolio returns.
Tax-loss harvesting is an important strategy investors should be considering this time of year. With tax season approaching, now is the ideal opportunity to explore how tax-loss harvesting could potentially lower your tax bills and improve your returns.
What is Tax-Loss Harvesting?
Tax-loss harvesting involves selling securities at a loss to generate capital losses that can be used to offset capital gains from other investments. For example, if an investor realized $10,000 in capital gains from selling stock but also incurred $5,000 in capital losses from selling other stocks at a loss, the losses would offset some of the gains. So, only $5,000 of the gains would be subject to capital gains tax.
Tax-loss harvesting takes advantage of the tax code which allows capital losses to offset capital gains dollar-for-dollar. Short-term losses must first offset short-term gains, and long-term losses offset long-term gains. If losses exceed gains in either category, then such losses can be netted together to create a net taxable gain or loss. If total losses exceed total gains, up to $3,000 of excess losses can be deducted against ordinary income. Any remaining losses carry forward to offset gains in future years.
Short-Term vs. Long-Term Rates
The IRS categorizes capital gains or losses as either short term or long term:
- Short-term capital gains and losses come from the sale of an investment that was held for one year or less.
- Long-term capital gains and losses are those recognized on investments sold after one year.
The one-year threshold is crucial, because the IRS typically taxes short-term investments at a higher than the long-term rate. There are seven ordinary short-term tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
Conversely, long-term capital gains taxes for are generally simpler and lower. These rates fall into three brackets: 0%, 15%, and 20%.
For comparison purposes, the following are the tax rates for the 2024 and 2025 tax years, respectively, based on 2024 and 2025 tax years based on income and filing status:
2024 Long-Term Capital Gains Tax Rates
| Capital Gains Tax Rate | Income – Single | Married, filing separately | Head of household | Married, filing jointly |
|---|---|---|---|---|
| 0% | Up to $47,025 | Up to $47,025 | Up to $63,000 | Up to $94,050 |
| 15% | $47,026 – $518,000 | $47,026 – $291,850 | $63,001 – $551,350 | $94,051 – $583.750 |
| 20% | More than $518,000 | More than $291,850 | More than $551,350 | More than $583,750 |
2025 Long-Term Capital Gains Tax Rates
| Capital Gains Tax Rate | Income – Single | Married, filing separately | Head of household | Married, filing jointly |
|---|---|---|---|---|
| 0% | Up to $48,350 | Up to $48,350 | Up to $64,750 | Up to $96,700 |
| 15% | $48,351 – $533,400 | $48,351 – $300,000 | $64,751 – $566,700 | $96,701 – $600,050 |
| 20% | More than $533,400 | More than $300,000 | More than $566,700 | More than $600,050 |
Source: Internal Revenue Service
Why Act Now?
While tax-loss harvesting is typically done at the end of the year, investors can use this strategy any time. However, reviewing realized gains and losses at year-end allows time to implement tax-loss harvesting strategies before the tax filing deadline. Selling losers over the next few months can provide tax savings on this year’s return. Acting now also gives more time to avoid wash sales by waiting 30 days before repurchasing the same security.
What Are the Key Benefits?
There are two major benefits of tax-loss harvesting:
- Lower current year tax bill – Harvesting losses reduces taxable income for this year, putting money back in your pocket.
- Increased returns long-term – Deferred taxes can remain invested and compound over time. This can boost portfolio value down the road.
It’s an opportunity to save on taxes and potentially improve returns. Tax-loss harvesting puts losses to good use.
Key Considerations
| Benefits | Drawbacks |
|---|---|
| Lower capital gains taxes | Selling prematurely if security recovers |
| Portfolio rebalancing | Portfolio unbalanced if done wrong |
| A more efficient liquidity event | Higher transaction fees from asset sales |
Final Thoughts
Tax-loss harvesting remains a powerful but underutilized tool for investors. It can be an important part of comprehensive year-end tax and portfolio management discussions, and it can help optimize after-tax returns while maintaining target allocations.
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