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By Dr. James M. Dahle, WCI Founder
I've been teaching people to tax-loss harvest here at The White Coat Investor for more than a decade. Only once during that time period did I receive pushback from someone about doing it. They didn't have any sort of legal or ethical issue with it. They simply questioned whether it was a good use of a doctor's time. I do think it is something worth learning to do if you have enough interest to manage your own portfolio, but it's not hard to make a case against doing it.
I'm not wealthy because I tax-loss harvest. I'm wealthy because I made a lot of money, saved a big chunk of it, and invested it in a reasonable way. Tax-loss harvesting is, at best, icing on the cake. At worst, it's actually impeding the building of wealth.
What Is Tax-Loss Harvesting?
Before we get too far into this article, let me briefly explain what tax-loss harvesting is. If this isn't enough detail, see the big article about it at the link above. Basically, when you have a realized loss on an investment, you can use $3,000 of that loss against ordinary earned income each year and an unlimited amount of that loss against capital gains. So, it does not really ever make sense to hold a taxable investment with a loss. However, you do not want to “sell low” after a loss; that's a recipe for bad investment behavior.
To capture that loss to use on your taxes without selling low, you simply exchange the asset for one that has a high correlation with the original asset but is not, in the words of the IRS, “substantially identical.” In practical terms, substantially identical basically means the same investment (same CUSIP number). You can't exchange a Vanguard Total Stock Market Fund for the Vanguard Total Stock Market ETF, but you can exchange it for the Vanguard Large Cap Index Fund or the Vanguard 500 Fund, which have a correlation of 0.99 with the Total Stock Market Fund. There is also a “wash sale” rule that does not allow you to buy the fund you just sold for a loss within 30 days before or after the sale, which further complicates matters (although interestingly, it does not apply to cryptocurrencies under current law.)
10 Reasons Not to Tax-Loss Harvest
Now that you know what it is, let's talk about why you may not want to bother with it.
#1 The Tax Break Isn't That Big
Your deduction is limited to $3,000 a year, and it hasn't increased the entire time I've been investing. It's definitely not indexed to inflation. My marginal tax rate is 42% between federal and state, so it's $3,000 x 42% = $1,260. That represents 4-6 hours seeing patients in the ED (or maybe a full shift after tax). Only you can judge how much your time and hassle are worth.
If you are in a situation where you can save a lot more than $3,000 a year because you have other reasons to have capital gains, then it can continue to make sense to tax-loss harvest regularly. But if not, you could probably generate an entire lifetime of $3,000-per-year deductions with a single transaction in a bear market if you have any sort of a reasonably sized taxable account. Imagine you have a million dollars in stocks, and the market drops 40%. It wouldn't at all be unusual to book $200,000 in losses from an event like that.
But if you own a small business, a practice, or a bunch of property you expect to sell at a gain in the future, then it can make sense to try to keep acquiring losses. We may end up selling WCI at some point down the road, so I'm still tax-loss harvesting. But I don't even really bother any more unless it's a six-figure loss.
#2 It Might Be Just a Deferral of Tax
In some cases, you are simply deferring the payment of your tax, particularly if you are using your capital losses from tax-loss harvesting against capital gains on the same securities down the road when you spend the money. If you save $1,260 in ordinary income taxes and then later pay $3,000 x 28.8% = $864 in capital gains taxes, your saving is now down to just $396 (28.8% is my federal plus state marginal tax rate on long-term capital gains.) The longer you can defer taxes the better, but this tax break is significantly larger if you never sell those securities that you tax-loss harvested (instead you could donate them to charity after a year or leave them to your heirs to get a step-up in basis at death). This is particularly noteworthy in an Intentionally Defective Grantor Trust like ours that will not get a step-up in basis at death on those securities.
#3 Not Worth Hiring Someone to Do
Some people look into hiring a robo-advisor or even a full-service financial advisor just because they find tax-loss harvesting overwhelming. The robo-advisors certainly plug this as a big value-add for you. But the truth is that advisory fees cost a lot more than tax-loss harvesting is going to save you. Imagine you're paying 0.25% with Wealthfront or Betterment on a $2 million portfolio. That's $5,000 a year. You're paying $5,000 to save $1,000 (or maybe less). There better be something else you really value that they are offering. It could be even worse if you are overpaying for advice. Tax-loss harvesting can be a marketing tool. Know what it's really worth to you so you don't fall for the marketing pitch.
#4 More Complex Portfolio
When you tax-loss harvest, you had better be exchanging into something you are willing to hold long term because you may very well end up holding it long term (unless you give it away to charity). But even if you are willing, you will end up with a more complex portfolio. My parents have a relatively simple portfolio, but back at the beginning of the pandemic, I grabbed them a few tax losses in their little taxable account (I couldn't get them to spend their RMDs so we just reinvested the money in taxable.) But now they're stuck with TSM, a large cap index, and a 500 index in their taxable account until they die or decide to spend more than their RMD in a given year. The portfolio is not as simple as it could be.
Now, imagine you have a taxable account with four or five different asset classes in it and two or three different funds for each asset class. Tax-loss harvesting has made your life more complicated. And for what: $400 a year? One could very reasonably decide that isn't worth it, especially given that the $3,000-per-year limit is not indexed to inflation and that it will become less and less and less each year in real, after-inflation terms.
#5 Have to Watch the Markets More Closely
I pride myself on not looking at my investments for months or even years at a time. Aside from the hassle factor, I actually go off-grid for weeks from time to time where I couldn't look at my investments if I wanted to—at least not without a satellite device/phone. But when market drops are rapid and severe (like the Coronabear of March 2020), you might miss out on a big tax-loss harvesting opportunity.
Aside from that, tax-loss harvesting makes you look at the markets at precisely the time when, behaviorally speaking, maybe you shouldn't be looking at the markets. I wonder how many people have gone to tax-loss harvest and ended up panic-selling?
#6 Can Get Burned During the Transaction
I try to make as a few trips through the “Wall Street casino” as possible with every invested dollar. Commissions, bid-ask spreads, and impact costs can add up after a while. But a bigger problem, at least if you are using ETFs, is that the market can rise a bit between the time you sell the first ETF and the time you buy the second one, especially on a volatile day when tax-loss harvesting is most tempting. It doesn't take too much of a rise to eliminate the entire benefit of claiming the loss.
This isn't an issue if you are using traditional mutual funds and are just exchanging them at the end of the day. But I feel like, Murphy's Law being what it is, the prices of the ETFs I'm exchanging usually go up between the sale and the buy when you would think that half the time it should go down.
This is an even bigger deal if you have elected to wait 30 days to buy back the same security rather than exchange immediately to a similar one.
#7 Unqualify Dividends
A lot of people forget about this little rule. If you don't own a security for 60 days around the time a dividend is paid out, that dividend becomes unqualified even if it would otherwise qualify for the lower qualified dividend tax rate. So, frenetic tax-loss harvesting in March-April, June-July, September-October, and December-January can easily cost you more in additional taxes on the dividends than you will save with the losses. Another great reason to only tax-loss harvest occasionally.
#8 Can't Put Investments on Autopilot
This is one of the best arguments against tax-loss harvesting. I bet not a week goes by that I don't have someone ask me how they can tax-loss harvest when they are automatically buying mutual funds every month. Automation is a very powerful investing tool, but it does not play well with tax-loss harvesting. You pretty much have to choose one or the other.
#9 Can't Reinvest Dividends
I don't reinvest dividends in my taxable account, and the main reason is just to limit the number of tax lots I have (although it assists a bit with rebalancing too.) The truth, though, is that Vanguard, Fidelity, Schwab, etc. all do a fine job of keeping track of all those tax lots for you. The real issue is that those reinvested dividends can cause an unintended wash sale. Just like you can't leave your investments on autopilot and tax-loss harvest, you can't really reinvest dividends and tax-loss harvest. Would you benefit more from reinvesting dividends than tax-loss harvesting? It's entirely possible.
#10 Impact on IRA and 401(k) Investing
Wash sales occur when you buy the same thing you just sold, even if you did so in an IRA. The IRS is very clear that IRAs are included in the wash sale rule (although if your IRA and taxable account are at different institutions, I have no idea how they would ever find out). Whether 401(k)s are included is unclear. But now you have to watch what you are doing in all of your accounts just to be able to tax-loss harvest. You either have to use different securities in taxable or really be careful not to buy in a retirement account within 30 days of tax-loss harvesting. Now you may not be able to reinvest dividends in retirement accounts either!
The bottom line is that if you have been looking for an excuse not to tax-loss harvest, there are plenty of them in this post. I'm certainly tax-loss harvesting a lot less frequently than I used to—and after reading this, I bet you will too.
What do you think? Do you tax loss harvest? Why or why not? Comment below!
Interesting read. Thank you for the great summary. I’ve TLHed a few times and am intrigued by your choice to not automatically invest dividends. I’ve struggled with that decision in the past. Ultimately, I decided to auto-reinvest so I don’t have to check my account balances too often and commit portfolio suicide with bad behavior. It would be nice if Vanguard could tell me when a dividend paid so I could know when to log in and reinvest it manually. Do you have any tips/tricks for managing this? Or do you just log in quarterly and reinvest on a set schedule? Thanks
Actually, Vanguard is pretty good at publishing their dividend schedule. It helps well with further planning.
I invest once a month. Whatever income I had that month whether from seeing patients, WCI, taxable account dividends, return of capital from a real estate deal, interest whatever. I add it all up, carve out a third for taxes, allocate some to spend for the month, and invest the rest.
This is the post I’ve been waiting for. Reading the comments it looks like not everyone understands this concept yet which I’m surprised by since you wrote about it so much. I’m what some would perhaps call an aggressive tax loss harvester. Harvest a lot and donate 6 figures of appreciated shares annually. With that strategy I have more losses right now than saved up capital gains in the market but have other gains in real estate and alternative investments that i can use the losses for one day.
The only one of these negatives that has been a real concern to me is the qualified dividends issue. It’s hard to keep track of but can totally wipe out any potential gain from this and actually hurt you. Just to clarify, if I have the big three (total stock, total bond, international) essentially and their harvesting partners, can I harvest with impunity in January, February, May, August, and November? I think I might do that as a rule and only do large 5 digit losses other months going forward.
You can do it in those other months, just hold for 2 months on at least one side of the dividend. What you can’t do it frenetic tax loss harvesting around dividend time.
So I screwed this up with the dividend of VLCAX by a few days- however the dividend was 300 dollars, the TLH was >2k, so if that saves me 800 in taxes, and only cost me 120 in taxes, I still came out ahead. Is my math correct- dividends turning unqualified just means that they get taxed at ordinary income rates? I guess I was happy to not have enough in VLCAX to get a bigger dividend
Yes, that’s the difference.
There is a free website called trackyourdividends.com and you enter your stocks and ETF holdings and it will email you ex dividend dates and track your portfolio dividends and overall income throughout the year. Pretty handy
I think the best case against tax-loss harvesting is the notion of “reversion to the mean”. Selling a poorly performing company would likely have the danger of being at the low valuation of it’s mean. Of course there is the possibility that it is just a bad company.
Are you talking about doing TLH with a single stock?
With mutual funds it shouldn’t make any difference. Exchanging a total stock fund for an SP500 fund at the end of day NAV accomplishes the goal without ever being out of the market.
Not sure you understand the process. The idea behind TLHing is to sell but NOT be out of the market. You switch investments at market lows rather than bail out of the market.
A note about re-invested dividends and harvesting: This isn’t as big of a deal as I had initially thought. In my case I was harvesting a loss in a Fidelity Muni fund to switch to a Vanguard Muni ETF. Once I had decided to I switched my preferences so the April dividend would go to cash instead of be reinvested. I was planning to sell more than 30 days after the March dividend but needed to free up some cash to buy I bonds in April. I sold a few lots with the smallest losses because many of things you read suggest it will all get disallowed. In my case, the only thing that was disallowed was part of the loss on one lot equal to the number of shares that were purchased through reinvestment at the end of March (in my case this was less than $10).
I agree that TLH is overblown.
My problem (is it really a problem?) is that I virtually never have any losses.
Real estate depreciation has been my only tax savior. Even then I don’t enjoy the “recapture” down the road.
Most doctors can just spend less and invest more. Keep investing and taxes simple.
Best to take losses when short term.
The best use for STCL is the $3000 deduction and keep short term capital gains from being taxed at regular rates.
Agree, a little goes a long way.
I sold my practice this year and have more than 1M capital gains. As of today I have more than 100K loss in AMZN. I should sell AMZN and maybe buy VOO? TLH 100k in 2022?
What’s your plan with Amazon stock long term? If you plan to hold it, then I’m not sure what the best tax loss harvesting partner would be. You could take a chance and just wait 31 days to buy it back. You could buy an index fund and then switch back. You could try buying a few tech stocks that seem to have high correlation with Amazon and then buy it back. Hard to say which is best. Much harder to do TLHing with individual stocks than mutual funds.
If you’ve seen the folly of individual stock picking, then just exchange into whatever funds are in your written investing plan. If you don’t have a written investing plan, get one.
https://www.whitecoatinvestor.com/investing/you-need-an-investing-plan/
Given your situation, I’d be tax loss harvesting like mad this year. Any tax lot you have a loss on I’d be selling and buying something similar. But it’s important to think in terms of your overall plan as well.
1) What level of taxable investments do you need to “earn” $3k in tax losses to harvest – obviously this answer will vary year to year, but is there a rough ballpark?
2) Related to #1, is there a break-even point where earning $3k in harvested tax losses is preferential to contributing to a tax-protected account?
3) Would the answer to #2 change if I am anticipating a future need to offset capital gains (e.g. selling rental property, selling employer stock that was purchased at a discount)?
1) Not much. For example, the market is down 15% this year. So if you had $100K with a basis of $50K, and you harvested it after a 15% drop, you’d have $7,500 in losses, more than two years worth of $3K deductions. Now imagine you have a $1M taxable account. Or a $10M taxable account. At a certain point, you’re going to have way more than you’ll ever need at $3K a year.
2) Not really. The life long value of tax-protected growth (and asset protection) is very valuable. I would not preferentially invest in taxable just to get some tax losses.
3) I still wouldn’t do it. I’m a big fan of retirement accounts. Run the numbers on using one with some reasonable assumptions and I suspect you’ll end up with the same opinion.
I like TLH because it gives me more flexibility to sell into overly exuberant rallies and valuations without worrying about taxes (completely). The idea to just buy, hold, and do nothing works great in an extended bull market, but not so great in down times or in times of high volatility. That goes double now when bonds are getting crushed from already dismal yields and dividend yields are super depressed, so reinvestment potential off of cash flows is severely compromised. I wonder how many people didn’t sell any of the high fliers that started plummeting Feb 2021 bc they didn’t want to pay taxes. TLH helps to get out of that mindset. Unless you’re Warren Buffet, today’s winners are often tmrws lovers (speaking allocations, ie large cap vs small cap, us vs intl, etc. not necessarily this stock vs that).
Bottom line it’s a great strategy in choppy markets to fade rallies, and get back in at lower costs, knowing you might guess wrong and get back in too soon, which is what you harvest against fading the bear rallies until valuations revert back to something more palatable.
You’re just talking about trying to sell high, not tax loss harvesting. It’s not the same thing. When I tax loss harvested, my portfolio/asset allocation hasn’t changed. Market timing is not as easy as it looks.
Perhaps the point you’re trying to make is that when you have losses to offset gains, you’re more willing to rebalance like you should. I would agree with that. But I find it pretty easily to rebalance with tax protected accounts and new money. I’m 18 years into my investing career and financially independent and I have yet to sell anything in a taxable account just to rebalance.
I think there may be another reason. If you are going to retire before being eligible for Medicare, and intend to use the ACA subsidy, having shares with a higher basis would keep your MAGI for calculating the subsidy low. I know most of the readers of this site want an income in retirement which would price them outside the subsidy window but, as PoF has pointed out, you COULD have a six figure income in retirement and pay no taxes (https://www.physicianonfire.com/the-taxman-leaveth-taxes-in-early-retirement/). I need to run the numbers, but I may tax gain harvest if I have some lower-earning years running up to early retirement to raise our basis and get our MAGI lower for subsidy purposes. Please correct me if I’ve got this all wrong!
This is exactly what I am thinking.
Plan to accumulate a very large bank of STCLs throughout my working life all the while taking the $3k/year deduction to my ordinary income (the last dollar of which is taxed at 35-37%). When my wife and I retire in our late 40s, we can pull from our taxable account for many years all the while paying 0% Federal income tax. We can use those accumulated capital losses to draw more at 0% or create the space to do several Roth conversions at very low tax rates.
If we retired this year filing MFJ, between the standard deduction and the 0% rate on LTCGs, we could take up to $109,250/year of capital gains at 0%. With no mortgage payment, this would be enough for us but the STCL bank allows us to take even more beyond that.
Great discussion of TLH.
For those whose investments are all in cap weighted index funds, there may be no time when they plan to realize any gains. This would leave them with nothing to gain for harvesting beyond $3,000.
At retirement, if they are going to live on part of RMDs and SS, they may have never realize gains in their lifetimes. For them, the losses above $3,000 would never be used.
There are also costs of TLH in that it makes your tax returns more complicated. If you never hold the same funds in retirement accounts as in taxable, you save yourself a lot of hassle in checking the dates of purchases and sales. But simply entering and verifying the sales on your tax return takes time.
Interesting discussion of TLH in Rational Reminder podcast 158.
Also see the paper
“An Empirical Evaluation of Tax-Loss Harvesting Alpha*”
Shomesh E. Chaudhuri,† Terence C. Burnham,‡ Andrew W. Lo
Available for free from SSRN. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3351382
They acknowledge but did not calculate the results for the case where the investor has no gains they wish to harvest. They agree that this would lower the value of TLH for those who plan to hold their assets till death.
I have a $2 m taxable portfolio. Sizeable chunk is in mutual funds. Like it or not, it’s not unusual to receive cap gains distributions from the mutual funds from of up to $30,000-40,000 per year. If I’m sitting on a $40,000 loss, definitely it makes sense to harvest it to offset the cap gains. If not, I’m looking at coming up with an extra $6,000 to pay the taxes (assuming a 15% cap gains rate).
So it’s not just the $3000, in ordinary income that TLH can reduce, but the often sizeable cap gains that it can offset.
The article above doesn’t quite emphasize this point enough. Just my 2c
That doesn’t happen with my mutual funds. Sounds like you have some actively managed funds in your taxable account.
Can’t you also benefit from offsetting the long term capital gains from real estate syndications going full circle with these losses?
I don’t have a business to sell but I like the idea of having these around in case I get a big capital gains from the non-1031 exchange syndications I have.
Yes.