By Dr. James M. Dahle, WCI Founder
One benefit of a market trending down is that an investor can get Uncle Sam to share in their losses by tax-loss harvesting. Up to $3,000 a year ($1,500 married filing separately) in net investment losses can be deducted from your regular income. In a typical physician tax bracket, that's worth about $1,000 in cold hard cash. If you have more losses than $3,000, the loss can be carried over and applied to your future tax bills.
For many people, it is hard to sell a losing investment. You have to admit you didn't have the ability to tell the future. Once you admit that your crystal ball is always cloudy, you realize that the intelligent investor can take advantage of the downturn.
What Is Tax-Loss Harvesting?
You are allowed to deduct up to $3,000 per year of a short- or long-term capital loss from your ordinary income on your taxes. Losses also offset gains. This all takes place on Schedule D of IRS Form 1040. These losses are so useful that investment advisors, tax preparers, and financial gurus the world over recommend you book them any time you can. However, taxable losses generally show up after an investment goes down in value, not exactly the time you would normally sell an investment. Buying high and selling low is a losing proposition most of the time.
Thus, the birth of tax-loss harvesting.
When tax-loss harvesting, you get to claim the loss without ever selling low. You do so by simply exchanging one investment for a very similar (but, in the words of the IRS, “not substantially identical”) investment. You're still fully invested (and so haven't “sold low”) but still get to use the loss on your taxes.
How to Tax-Loss Harvest
I wrote about this in 2018 when describing how to tax-loss harvest through my Vanguard account. But here's a good rundown of how to think about it.
#1 Buy and Hold Investments You Want to Hold for a Long Time
If you're not jumping around in the market, market-timing, and speculating, then you've bought investments that you want to hold even if they go down temporarily.
#2 Harvest Losses in a Decline
When they decline in value, instead of panicking and just selling them completely, you “harvest the losses.”
#3 Trade for Something Similar
You get the tax benefits just for selling the losing investment. But if you don't trade it for something similar, you commit the cardinal investment sin of buying high and selling low. The wise investor SWAPS the losing investment for one that is highly correlated with it. The net effect is that your portfolio doesn't change substantially, yet you still get to claim the losses on your taxes. As an example: A typical exchange might be to swap the Vanguard Total Stock Market Fund for the Vanguard 500 Index Fund. These two funds have a correlation of 0.99, but nobody in their right mind could argue they are substantially identical. The first holds thousands of more stocks than the second, they have different CUSIP numbers, and they follow different indices.
Tax-Loss Harvesting Rules
There are a few important tax-loss harvesting rules.
Substantially Identical Rule
This means you could swap a Vanguard Total Stock Market Fund for a Vanguard 500 Index Fund, but you couldn't swap a Vanguard Total Stock Market Fund for a Vanguard Total Stock Market ETF. Those are substantially identical. Now, some people think the IRS really dives into the details of these transactions, but I don't know anybody who knows anybody who has ever been audited on this point. The IRS has bigger fish to fry. So, I really wouldn't spend any time worrying about it. Certainly, in this case, one fund holds thousands more stocks than the other, so it is an easy argument to make that they are not identical. You can also argue that two indices and the holdings themselves are different even if you're using a Total Stock Market fund from two different companies.
Wash Sale Rule
The easiest rule to screw up tax-loss harvesting is the wash sale rule. That means you can't turn around and buy the same security in the 30 days after you sell it—if you do, the basis is reset and that loss you were trying to get is washed away. You also can't buy it in the 30 days BEFORE you sell, UNLESS you also sell the shares you just bought. You also can't buy the same security in an IRA that you just sold in taxable. The tax code doesn't say you can't buy it in a 401(k), but I think that is at least against the spirit of the rules.
Be careful buying and selling frequently, of course. If you don't hold a security for at least 60 days around the dividend date, you will turn that dividend from a qualified dividend into a non-qualified dividend, eliminating a lot of the benefit of that tax loss.
60 Day Dividend Rule
Don't forget that owning a security for less than 60 days around (including before or after) a dividend date turns a dividend that would have otherwise been qualified into an unqualified dividend. You pay a much lower tax rate on qualified dividends than non-qualified dividends. So if you start frenetically tax loss harvesting, you could end up paying MORE in taxes. Slow it down, especially around dividend dates.
When to Do Tax-Loss Harvesting
In June 2018, there was a period of time where stocks dropped for about six days straight. There were similar episodes, at least for international stocks, in February, March, and May of that year, as well. If you had purchased an international stock index fund at any point during 2018, chances were very good by June 19 that you had a loss you could tax-loss harvest, especially if you had not already done it for that year. (Obviously the really astute probably already did this in February, March, or May.)
That's one example of when it would have been a good time to tax-loss harvest.
Remember, though, you're likely having to pay administrative costs whenever you're exchanging funds. You need to make sure that your tax gains will be higher than the costs you're having to pay.
An Example of Tax-Loss Harvesting
The Stock Purchase
On March 14, you bought $5,000 worth of Vanguard Total Stock Market Index Fund (TSM) at a price of $32.64 a share and $5,000 worth of Vanguard Total International Stock Market Index Fund at a price of $15.67 a share.
The Exchange
On Friday, August 5, you exchanged the TSM for Vanguard Large Cap Index Fund, selling the shares of TSM at $29.99 a share and exchanged the TISM for Vanguard FTSE Ex-US Index Fund, selling the shares of TISM at $14.66 a share.
The new funds have a correlation with the old funds of something close to 0.99. It's essentially identical for investment purposes. But per the IRS, the investments are not “substantially identical” for tax purposes.
Booked Loss
You have now booked a total loss of $728.22. Given a 32% federal tax bracket and a 5% state tax bracket, you've now saved yourself $728.22 × (0.32+0.05) = $269.44 in taxes. The best part is that if the market trends down, you can do it again tomorrow. You just have to remember not to go back to TSM and TISM for at least a month, or the “wash sale” rule eliminates your tax break.
The Critics
Some critics point out that you'll end up paying later the tax you save now because you've lowered your tax basis on the investment. That is true, but there are several reasons why it is still a good idea.
- First, there's a tax arbitrage here. You get to deduct taxes at your regular income tax rate, 37% in the example, but only have to pay at the capital gains tax rate later, say 15%.
- Next, there is a benefit to deferring the taxes as long as possible. Money now is worth more than money later—due to inflation and also due to the time value of money.
- Last, it's possible you'll NEVER have to pay taxes. If you later use the shares for a charitable donation (in which case neither you nor the charity pays the tax) or if you die and leave them to heirs (in which case there is a step up in basis to the value of the investment on the date of your death), then you'll never have to pay that tax.
Remember that you can only tax-loss harvest in a taxable account.
But if you do have a taxable account, the next time there is a downturn in the market, see if there is some tax-loss harvesting you can do. It won't necessarily allow you to FIRE tomorrow, but it could provide some nice tax savings.
What do you think? Do you tax-loss harvest investment losses? Why or why not? Comment below!
[This updated post was originally published in 2019.]
Hi WCI, two questions for you:
1. Has the IRS made any statements about wash sales and TLHing into a 529 account? Ideally, I would like to sell VTI shares in my taxable account, then transfer the funds into my son’s 529 account and purchase VTI shares inside it.
2. If I TLH more inside my taxable account and plan to sell VTI shares at a loss and buy VOO shares, how soon do I need to wait to rebuy more shares of VTI? (I typically buy new shares of VTI on the 1st of each month with excess savings from the previous month after I’m paid).
Thanks!
1. Not that I know of. I think that would be fine and you could claim the loss.
2. 30 days. Maybe wait for 31 just to be sure.
If I have VTSAX inside my Roth IRA that is auto-reinvested, I assume this would not cause a problem if I were to hold and attempt to TLH VTI in a taxable account, right?
Separate and unrelated question, any benefit to setting up our taxable brokerage account as tenancy by the entirety (TBE), vs just a joint account, vs as an individual owner account? I do live in a state that recognizes TBE.
That could cause a wash sale, yes. But VTSAX doesn’t pay another dividend until the end of March, so in February you should be able to get away with it!
I’d do TBE for some additional asset protection if allowed.
Long time reader so fairly aggressive TAx Loss Harvester. I’ve noticed the last two years I’ve had more unqualified dividends. I think it’s because I’m harvesting funds I’ve held less than the required time to make them qualified. Do you pay attention to that or figure it’s a small enough amount it’s worth ignoring and just doing the harvesting?
Yes. Watch that 60 day rule. Best not to be too aggressive with the TLHing.
https://www.whitecoatinvestor.com/the-60-day-qualified-dividend-rule/
There are many articles about how to avoid wash sales, but I can’t find anything about how to calculate the basis adjustment if you already caused a wash sale. For normal stocks and funds your broker will calculate it for you, but if they don’t (non-covered security) what do you do?
Your basis stays the same as it was before the sale. So keep a record of it. The “calculating” should be able to be done with 3rd grade math.
So I have a vtiax index fund. I turned on spec ID the other day to prepare for tax loss harvesting. I realize that I currently have a $5,000 loss on the total fund but the total fund has about 15 different tax lots. Am I supposed to tax loss harvest each lot individually since I am now on spec ID. Or is there a way to just exchange the whole entire fund. Or does it matter at all and I can do either way? Thanks
You can do either, but the best way to do it is to use SpecID and only tax loss harvest the lots with losses.
Another question. Where/how do you keep track of your booked losses? Do you just keep a spreadsheet keeping the total losses and when/how you use them on your tax returns?
They’re carried forward on Schedule D from year to year.
Is there a maximum you should TLH? I understand it’s $3k/year and then rolls over to the next year (is that forever or a certain number of years)? I have enough losses currently (90k) to use the $3k/yr for decades. Thank you.
It’s okay to have more, but the law of diminishing returns certainly applies.
Could you please clarify the wash sale rule with transactions that occur within the IRA account?
Specifically, if I purchased SPTM (total stock market ETF) in my IRA account 20 days ago, and I’m trying to perform tax loss harvesting by selling SPTM in my taxable account, do I also need to sell the SPTM purchase in my IRA account from 20 days ago? Or, does the wash sale rule only prevent me from re-purchasing SPTM in the upcoming 30 days in my IRA account?
Another way of stating the question – I understand that I would need to sell all SPTM purchased in the taxable account within the past 30 days, and I cannot purchase SPTM in the upcoming 30 days in my taxable or IRA account. But do I also need to sell all SPTM in my IRA account that was purchased in the last 30 days?
Hello,
Great post! I just TLH the other day from VTSAX to VFIAX for a loss of 1,000. Now VFIAX is down and it has been less than 30 days. If I sell all VFIAX and buy VFWAX is this a wash sale? I think it would be since it is less than 30 days but, have seen it mentioned if I sell all shares it would not be?
Thank you,
No. But beware the 60 day rule on qualified dividends.
Thanks for the recent update article on tax loss harvesting! I am going to start doing this now given the recent down turn. Through a long story I’ll move past, I have about $6000 of Vanguard total bond index in a taxable e-trade account and that is the only holding in that account. It is down more than $1000 currently and I plan to Tax loss harvest this. But, we are moving our e-trade accounts over to Vanguard to simplify our lives. Because the rollover is into a joint account, the paperwork is really annoying. Can I just sell the holding to get the account to $0, then buy something (obviously different) in our Vanguard taxable account and still claim the loss against ordinary income right? I’ve never sold a stock/bond. I take it the financial institution provides paperwork to demonstrate the loss and then our accountant puts that on Schedule D as a running tally?
Yes. You don’t have to buy ANYTHING to claim the loss. The point of buying is to avoid changing your asset allocation.
Hi,
Am I correct in my understanding that TLH short term losses first cancels out short term gains and then long term gains?
Thank you.
Yes. You can work through Schedule D to see the details.
I am attempting to sell FSKAX (mutual fund) for VOO (ETF) and tax loss harvest it. Fidelity will not let me simply exchange it but is rather requiring me to sell FSKAX then I’ll have buy VOO the next day. Is that ok for TLH purposes? Thanks
Yes, although you could get burned if the market rises in between sale and purchase. Could go the other way too and you could score. Best to stick with fund-fund and etf-etf when able.
Been TLH for a couple years now but about to get married. How would one go about investing and TLH when married? If I hold VTSAX in my account does that mean I can’t hold it at all in my spouse’s if I want to stay clear of wash sales or would it be allowed if I TLH VTSAX from both accounts on the same day?
I guess my question is: how do I continue to TLH while still maintaining similar positions (i.e. a three fund portfolio) in my spouse’s account?
The IRS will consider it all one big account. I recommend you do too. If you choose not to and deal with that extra complexity for asset protection or some other reason, then you’ll need to be aware of the wash sale rules and not buy in one account within 30 days of selling in the other.
Hi WCI-
You state above that “You also can’t buy it in the 30 days BEFORE you sell, UNLESS you also sell the shares you just bought.”
Do you have a reference for this? I would like to do some TLH in my Vanguard accounts, but have bought funds earlier this month. I can sell these lots for a loss, but have searched and searched and cannot find a reference for the above.
Or maybe it’s just common sense and I don’t have a strong enough grasp of the language of the rule …
Thanks in advance.
Yes, it’s common sense. Go ahead and try it and see what happens. 🙂
Maybe this explanation will help: Imagine you own 10 and only 10 shares of something. You buy 5 more shares. Then the price drops 5 days later. You decide to tax loss harvest all 15 shares. You should be able to claim the loss, right? Who wouldn’t consider that reasonable? But what if you only wanted to tax loss harvest 5 of the original 10 shares. That’s a wash sale because you bought 5 and then sold 5 just a few days later, well within the 30 day rule.
Hi, I have a quick question. For whatever reason I have the same stock in my SEP – IRA as well as my brokerage account. I know you can’t sell the stock in the brokerage account and buy it in the IRA when tax loss harvesting, but can I sell the stock in the brokerage account to harvest a loss and leave the stock in the SEP untouched?
If not I’m assuming I would have to just eat the loss in the SEP to harvest it in the brokerage.
Thanks for your help!
Yes. But you’re changing your asset allocation if you don’t buy something similar somewhere at the same time.
Yes, as long as you didn’t buy stock in IRA in past 30 days and don’t buy for another 30. If you did, you’d need to sell those lots. (My understanding)
Is it too late to to tax loss harvesting at this point?
I don’t usually check my accounts often but it looks like I’ve lost about $5,000 this year on 2 accounts, one at Vanguard where I have total stock market index and the other at Fidelity where I have a little bit of Tesla stock. Is there a good option to do TLH where I have 2 taxable accounts at both places? what could I trade the Tesla stock for?
I’m a single parent and looks like I can only claim $1500 this year.
I’ve never done TLH before and appreciate your help.
No, you can always tax loss harvest, but if you want to use the loss on your 2022 taxes, you need to sell in 2022.
If you have losses at Vanguard and Fidelity, you’ll need to sell at both places.
This is an issue with individual stocks, tax loss harvesting partners aren’t as good. Personally, I’d sell the Tesla stock and diversify into an index fund, but I’m not really sure why you bought the Tesla stock in the first place.
It’s $3K for single and MFJ. It’s only $1500 for MFS.
Hey- I’m hoping to take advantage of tax loss harvesting to get rid of some mutual funds I have with high turnover rates/capital gains taxes. Over the course of the year, the majority of my investments are at net negative (I’m early career so all are within last 5 years). The total value of the funds I’m looking to swap out is approx 20k. Should I tax loss harvest all of them? What are the pros and cons of doing so? Thanks!
If you’re underwater on all of them, sure. These are called “legacy investments”, stuff you bought in taxable but don’t really want now. If there is no tax cost (and even a tax benefit) to get into what you really want, then do it ASAP.
But be sure there is no tax cost. Stuff you bought 5 years ago almost surely has some capital gains unless it was really a taxable investment. But you may have enough losses to cover those gains. Just have to compare you basis to current value.
I own a lot of VTI but haven’t bought any for a while. On Dec 10, I purchased $20,000 more of it. (It was as a replacement for some VONG that I sold for a loss.) VTI has now gone down and I’d like to sell the $20,000 lot I purchased for a loss before the end of the year (using the Fidelity feature that allows you to specify the lot you are selling). Is that a wash sale? Does it matter than I’m not selling all of my VTI holding?
I just remembered that I bought $10,000 of VTI on Dec 5. If I sell both these recent purchases for a loss — both the Dec 10 $20,000 and the Dec 5 $10,000 — is there a wash sale? This assumes, as before, that I am not selling any of the VTI that I purchased years ago.
No wash sale.
When tax loss harvesting, should you sell the stocks with the least net loss so that you “lose” less money or sell the stock with the highest net loss so you have more to tax-loss harvest?
Both.
Sell all the stocks with losses.
But you should look ahead to what replacement investment you will be using and make sure you are comfortable owning it. This is not only to make sure it is similar enough to what you already own that you don’t skew your allocations. It is also because you might own it for longer than you think. When the market goes back up and stabilizes, you can’t exactly replace the replacement with one of your old favorites — even if you wait 30 days to do so. Chances are it has gone up in value, so you are looking at paying taxes on short-term gains (at your regular income tax rate) when you sell it. And if you wait a year, the gains, while long-term, will probably be greater.
You might think you will just get rid of that dog when the market goes down the next time. But to do so, the market will have to go down even more than it did when you took your loss, which (fortunately for other reasons) isn’t likely. So vet your replacements well since you may be stuck with them for a while.
But you should look ahead to what replacement investment you will be using and make sure you are comfortable owning it. This is not only to make sure it is similar enough to what you already own that you don’t skew your allocations. It is also because you might own it for longer than you think. When the market goes back up and stabilizes, you can’t exactly replace the replacement with one of your old favorites — even if you wait 30 days to do so. Chances are it has gone up in value, so you are looking at paying taxes on short-term gains (at your regular income tax rate) when you sell it. And if you wait a year, the gains, while long-term, will probably be greater.
You might think you will just get rid of that dog when the market goes down the next time. But to do so, the market will have to go down even more than it did when you took your loss, which (fortunately for other reasons) isn’t likely. So vet your replacements well since you may be stuck with them for a while.
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Tax loss harvesting is one of the best tax strategies around. It’s unfortunate that some unsophisticated investors never understand the concept. I have a client who had a $300k realized gain from a sell of stock earlier in the year. He had an unrealized loss of $400k from the implosion of Tesla. The client refused to take the loss to offset the gain and decided it was better to pay the tax on the gain. Am I missing something?
Not unless the client was worried about not owning Tesla for 30 days or being able to find a good TLH partner for it.