Tax-loss harvesting is a tried-and-true strategy for lowering taxes and potentially helping increase after-tax returns. It allows you to use investment losses to offset gains and/or income to ease your tax burden.
Taxes
Maximize your tax savings with tax-loss harvesting
Learn how tax-loss harvesting with Vanguard can help you offset capital gains and reduce your tax liability while optimizing your investment strategy.
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Points to know
- Tax-loss harvesting is an effective tax-saving strategy that involves selling securities at a loss to offset gains in other investments or income. By using this method, you can help reduce your capital gains and/or income taxes.
- If your capital losses exceed your capital gains, you can reduce your taxable income by up to $3,000 for the year. You can also carry forward any excess losses to offset capital gains and income tax in future years.
- Tax-loss harvesting is complex, and it's important to consult with your financial advisor or tax professional to make sure you're maximizing its benefits and adhering to any applicable IRS rules.
What is tax-loss harvesting?
Tax-loss harvesting is when you sell investments at a loss and use those losses to offset gains in other investments. You then take the money from the sale and use it to buy an investment that fills a similar role in your portfolio, so you stay invested in the market. This last point is critical—it's what distinguishes this powerful tax strategy from trying to time the market or locking in losses, and it provides the potential for increasing after-tax returns.
When you tax-loss harvest, you'll pay taxes on your realized capital gains for the year, meaning you'll only consider your net gains—the amount you gained minus any investment losses you realized. So, if you know you're going to have some realized gains, you may want to see whether you have any opportunities to realize losses to offset them. For example, if you need to rebalance your accounts, you could sell shares of funds or stocks that have lost value since you purchased them.
Benefits of tax-loss harvesting
Save on taxes
When you file your income taxes, you can use tax-loss harvesting to reduce the amount you would have owed on capital gains and income. If you don't have realized gains in the same tax year, you can carry forward realized losses to offset income or gains in future tax years.1
Grow your portfolio
If you reinvest your tax savings, they'll have the opportunity to compound over the life of the investment, greatly increasing the financial benefit.
Reduce cost and risk
If you have assets you want to sell because of high costs or risks, tax-loss harvesting gives you a way to do so while potentially lowering a large tax bill.
Turn volatility into opportunity
Markets can't be controlled—but you can strategically control things like costs and taxes.
How tax-loss harvesting works
Learning how to harvest tax losses is key for helping put your money to work. If you have realized capital gains, you can offset them by selling securities from one of your taxable accounts at a loss and reinvesting the money in a similar investment or rebalancing, if needed. When reinvesting the funds, it's important to be aware of the IRS wash-sale rule. This rule states that if you buy the same investment or any investment the IRS considers "substantially identical" within 30 days before or after you sold at a loss, you won't be able to claim the loss.
At tax time, you have the option to reinvest your tax savings to put more of your money—and the power of compounding—to work for you.
If your losses are greater than your gain
A year when your realized losses outweigh your gains is never fun, but by using tax-loss harvesting, you can recoup some of those losses when you file. You can use up to $3,000 in net losses to offset your ordinary income (including income from dividends or interest).
Note that you can also "carry forward" losses to future tax years.
Tax-loss harvesting limit example
Let's put some numbers behind tax-loss harvesting to bring it to life and demonstrate how it can help you save. Say you sell Investment A at a loss of $30,000, but you end up with $25,000 in realized gains from Investment B. Your losses would offset your entire gain, which means that you won't pay capital gains taxes—and you'll have $5,000 in losses left over. Under current tax rules, you can use up to $3,000 of that loss to offset your ordinary income, and you'd be able to use the remaining $2,000 to offset gains or income in future tax years. Your estimated total tax savings in the current period from using tax-loss harvesting would be $4,800, based on a long-term capital gains tax rate of 15% (applied for holding the funds for one year or more) and an ordinary income tax rate of 35%.2
Investment A: Use $25,000 in losses to offset $25,000 in gains |
Investment B: Capital gains taxes owed is $0. |
reduce their ordinary income. |
By tax-loss harvesting, the investor has a total estimated tax savings of $4,800 ($3,750 + $1,050). |
| Use remaining $2,000 to offset future gains. | |
This hypothetical example doesn't represent any particular investment and the estimated tax savings aren't guaranteed.
Tax-loss harvesting rules
As you plan for and complete your taxes, be sure to review tax resources like tax information for Vanguard funds. If you plan to tax-loss harvest, it's important to be familiar with tax basics. Key examples of these include the wash-sale rule, offsetting capital gains with losses, any rules specific to your state, and the deadline to process transactions.
Wash-sale rule
IRS rules prohibit you from claiming a loss if you sell an investment at a loss then immediately repurchase it (known as a "wash sale").
If you buy the same investment or any "substantially identical" investment within 30 days before or after selling it at a loss, the loss will be disallowed. The IRS wash-sale rule applies not only to purchases of substantially identical securities within the same account, but also to purchases of substantially identical securities acquired in other accounts owned or controlled by you or your spouse or partner, including tax-deferred accounts such as IRAs and 401(k) plans. Contact a tax advisor for guidance on tax-loss harvesting, including whether an investment is considered substantially identical.
Offsetting capital gains with losses
You can use realized capital losses to offset an unlimited amount of capital gains in a given year. For example, if you have $20,000 in capital gains and $20,000 in capital losses, you can offset the entire gain.
If your capital losses exceed your capital gains, you can apply up to $3,000 of the losses to offset ordinary income ($1,500 if you're married filing separately). You can also carry forward any remaining losses indefinitely to help offset gains or up to $3,000 of income in future tax years.3
State-specific rules
Since each state has its own tax laws and regulations, state-specific rules pertaining to tax-loss harvesting can vary. For example, if a state doesn't permit loss carryforwards, tax-loss harvesting could be less beneficial. Be sure to check the rules for your state and contact a tax professional with questions.
Tax-loss harvesting deadline
All transactions for tax-loss harvesting must be executed and settled by the end of the calendar year. The deadline for tax-loss harvesting is usually December 31. However, if that day falls on a weekend, it might be the preceding business day. Note that transaction settlement times can vary, so it's a good idea to complete all trades well in advance of the deadline to ensure they settle in time to be included.
Making cost basis count
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. There are various cost basis methods you can use to redeem your investments based on your investing style and tax situation. The specific identification cost basis method chooses specific lots of shares to sell. While it'll take more work on your part, using this method could help you reap the greatest tax benefits.
Vanguard Brokerage Services® offers the MinTax cost basis method to its clients. This cost basis method suggests which shares to sell in order to help deliver tax-savings. You can use MinTax when processing transactions to help minimize the tax impact in most (but not all) cases. Your tax impact depends on the transaction, your tax bracket, and other factors. We recommend you contact a tax or financial advisor to see if MinTax is right for you.4
When selling your shares, remember to consider the holding period. If you owned your investment for more than one year, you're subject to a long-term capital gains tax rate, which is typically lower than the ordinary income tax rate. If you owned the investment for less than a year, you're subject to a short-term capital gains rate that's taxed at your ordinary income tax rate, which is often higher than 15%. Long-term gains can only be offset by long-term losses, and short-term gains can only be offset by short-term losses.
Is tax-loss harvesting worth it?
Tax-loss harvesting can be a valuable strategy for many investors, but its worth depends on your financial situation and goals. It might be worthwhile if you're in a high tax bracket or have significant realized capital gains since it can offset those and reduce your tax liability. If you're in a lower tax bracket or don't have significant capital gains, then tax-loss harvesting might not be worth it since the benefits might be limited. Contact a tax or financial advisor to see if it might be right for your situation.
Advice offers automated tax-loss harvesting services
When it comes to tax-loss harvesting, automation doesn't just make the job easier—it can help increase the potential benefit. That's why Vanguard's advice services offer automated tax-loss harvesting. To claim losses, the IRS requires you to comply with a number of rules—something an automated service like Vanguard's builds into the technology. An automated tax-loss harvesting service never has to take a day off, and it can easily check for opportunities across dozens of investments and hundreds of investment lots.
Ready to get started with tax-loss harvesting?
Tax-loss harvesting is complex, but using financial advice that offers automated tax-loss harvesting can help simplify the process.
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1 Tax-loss harvesting involves certain risks. You may not see any benefit or you may experience a loss if:
- The investments bought with proceeds from tax-loss harvesting sales underperform the investments sold or have higher costs than the harvested securities.
- You reinvest your tax savings now and sell in the future when you may be in a higher tax bracket and subject to higher taxes. By selling a security at a loss now, you're effectively resetting the cost basis of that investment lower. If capital gains or ordinary income tax rates rise, the future tax liability caused by selling the investment with a lower cost basis in the future could be greater than the benefit realized by harvesting the loss now (including any compounding benefit from the tax deferral). You can also push yourself into a higher future tax bracket by embedding large capital gains into your investments from harvesting. In this case, the gains triggered through the sell down of your securities may increase your income and, subsequently, your marginal tax rate.
- You introduce significant portfolio tracking error into your portfolio by replacing harvested securities with different securities. When losses are harvested, you need to purchase replacement securities that would not be deemed "substantially identical" for the purposes of the IRS wash-sale rules. The degree of differentiation between the harvested security and its replacement can be viewed as the degree of risk you must take to harvest a loss.
- The return on reinvestments is negative over the long term.
- The frequent sale and repurchasing of investments results in disqualification of qualified dividend treatment, which means dividends will be taxed at ordinary income rates instead of preferred capital gains rates. To obtain qualified dividend treatment and receive the lower capital gains tax rate, you must satisfy a minimum holding period. For example, mutual fund shares must be held for at least 61 days of the 121-day period which began at least 60 days before the ex-dividend date of the security.
- After offsetting any capital gains and ordinary income, you have residual capital losses that carry forward indefinitely. If you carry forward large losses (beyond realized gains and the ordinary income offset), you may not be able to use them up in future tax years. Though there are no penalties associated with carrying losses forward, you may be incurring the risks of tax-loss harvesting without obtaining the primary benefits of the strategy.
2To encourage long-term investing, long-term capital gains receive special tax treatment. Most individuals are taxed 15% on their realized long-term capital gains. Investors subject to short-term capital gains rates are taxed at their ordinary income tax rate, which is often higher than 15%.
3 See IRS Topic no. 409, Capital gains and losses, available at https://www.irs.gov/taxtopics/tc409.
4 See Minimum tax method (MinTax) available at https://investor.vanguard.com/investor-resources-education/taxes/cost-basis-minimum-tax.
All investing is subject to risk, including the possible loss of the money you invest.
Neither Vanguard nor its financial advisors provide tax and/or legal advice. This information is general and educational in nature and should not be considered tax and/or legal advice. Any tax-related information discussed herein is based on tax laws, regulations, judicial opinions, and other guidance that is complex and subject to change. Additional tax rules, including state and local tax rules, not discussed herein, may also be applicable to your situation. Vanguard makes no warranties with regard to this information or the results obtained by its use and disclaims any liability for positions taken in reliance on such information.
We recommend you consult a tax and/or legal advisor about your individual situation before engaging in tax-loss harvesting. The IRS website at irs.gov also contains information that would be prudent for you to review about the consequences of engaging in tax-loss harvesting. The treatment of capital gains and losses, including the ability to offset gains with losses, is subject to current tax provisions. Please see IRS Publication 550, Investment Income and Expenses, for additional information. Tax-loss harvesting may also implicate state or local tax consequences for your particular situation.
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