Tax planning is a year-round process, not just something to be considered before the April deadline. Tax-loss harvesting is not a silver bullet but a way to generate some value from an underperforming asset.

When the markets or a particular security decline in value, investors can add another layer of efficiency to their portfolios by being mindful of wash sale rules and exploring opportunities like direct indexing, which we’ll address in this blog. 

Tax-loss harvesting is one strategy that is frequently discussed in our Boston financial planning meetings. It enables our clients to use market downturns to create potential tax advantages while maintaining a disciplined long-term investment strategy. 

Below, we’ll explain how tax-loss harvesting works, who may benefit, and why it’s worth making an important part of your portfolio strategy for taxable investments. At Sherr Financial Associates (SFA), we often help clients explore whether this approach fits their unique situation, strategy, and goals.

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What Is Tax-Loss Harvesting?

Tax-loss harvesting involves selling investments that have declined in value to “realize” the loss for tax purposes. These realized losses can offset realized gains elsewhere in a portfolio. Plus, if losses exceed gains, up to $3,000 annually may offset ordinary income, with additional losses carried forward to future years.

The core idea is straightforward: if you sell something at a loss, that realized loss can help reduce your realized gains and taxable income. But, like any tax strategy, the details matter, and professional guidance is usually required.

Using Down Markets to Your Advantage

Market declines can feel spooky, but they may also create opportunities for tax planning. During a down market, more positions may be trading at a loss relative to their purchase price. By strategically selling some of these positions, investors can “harvest” losses for tax purposes and re-invest in similar, but not identical, securities to maintain overall market exposure.

SFA Tip: Down markets should be viewed as lower-priced buying opportunities.

This doesn’t require timing the market or guessing when a rebound will occur. Instead, it’s about making thoughtful adjustments during downturns that could improve results and lower overall tax consequences.

Avoiding Wash Sale Rules

One of the most important considerations with tax-loss harvesting is avoiding the IRS wash sale rule. This rule states that the loss cannot be claimed for tax purposes if you sell a security at a loss and then buy the same, or a “substantially identical” security, within 30 days before or after the sale.

This is where planning becomes critical. For example, if you sell shares of one large-cap index fund at a loss, you shouldn’t buy the same fund immediately afterward. Instead, you might purchase a different large-cap fund or ETF that provides similar exposure without being considered “substantially identical.”

At Sherr Financial Associates (SFA), we help clients review options to maintain their investment objectives while avoiding mishaps that could disallow the benefits of harvested losses.

You Don’t Have to Be Wealthy to Benefit

Tax-loss harvesting isn’t just for high-net-worth households. Anyone with taxable investment accounts can make it part of their investment strategy. Tax breaks can be meaningful if you’re a young professional building wealth, a family planning for college expenses, or a retiree working with Boston retirement planners.

While the dollar amount of realized losses may differ depending on portfolio size, the principle is the same: a realized loss today may reduce tax liability in the future. When combined with other tax-efficient investment strategies, the cumulative impact can reduce your tax consequences.

How Direct Indexing Enhances Tax-Loss Harvesting

Direct indexing, owning the individual stocks of an index rather than a single ETF or mutual fund, has become more popular in recent years. One reason is that it allows for greater tax-loss harvesting opportunities.

This creates more opportunities to offset gains with losses each year. Boston financial advisors often recommend exploring direct indexing if you have the necessary assets and want more control over tax-efficient investing. 

Here’s why:

• In a mutual fund or ETF, you can only harvest a loss when the entire fund is down.
  
• In direct indexing, you own the individual securities. That means you can selectively sell the underperformers within the index while holding onto the winners you want to retain.
  

At Sherr Financial Associates (SFA), we help you evaluate whether direct indexing is appropriate for your tax situation and long-term plan for investing your assets. 

SFA Tip: It pays to keep in mind that your most significant financial risk is not the stock market’s volatility. It’s a failure to pursue your long-term financial goals. And, every dollar of unnecessary tax is one less for your future use.

Tax-Loss Harvesting Strategies in Boston

Working with tax planning advisors in Boston gives you access to professionals familiar with federal and state tax rules. Local investors often ask:

• How often should I review my portfolio for tax-loss harvesting opportunities?
• Does this strategy work in retirement accounts like IRAs or 401(k)s?
• Can this be combined with charitable giving or Roth IRA conversions?
  

Each situation is unique, but the general rule is that tax-loss harvesting only applies to taxable accounts, not tax-advantaged retirement accounts. The frequency of harvesting depends on factors like market volatility, portfolio size, and personal tax situation.

 Strategic Alternatives

While tax-loss harvesting strategies in Boston can be beneficial, there are a few caveats:

• Selling and buying securities can involve trading costs. These have decreased in recent years, but should still be considered.
  
• Replacing one security with another may cause slight changes to your asset allocation and diversification. Regular rebalancing helps manage these ratios.
  
• More sophisticated strategies, like direct indexing, require monitoring and technical support that not every investor has access to.
  

At Sherr Financial Associates (SFA), we emphasize that strategies like tax-loss harvesting should always fit within a broader financial plan and not be used as an occasional one-off strategy.

Who Benefits from Tax-Loss Harvesting?

• Those with taxable accounts who plan to remain invested for years can benefit by reinvesting proceeds into similar investments at a lower cost.
  
• Families in higher tax brackets may see greater tax offsets, but even investors with smaller portfolios can use harvested losses against gains and income.
  
• Those with portfolios large enough to use direct indexing can maximize harvesting opportunities.
  
  

Frequently Asked Questions About Tax-Loss Harvesting

1. How does tax-loss harvesting work in simple terms?

It means selling an investment at a loss to offset a taxable gain elsewhere in your portfolio. If your losses exceed your gains, you may use up to $3,000 per year against ordinary income, with additional losses carried forward to future tax years.

2. Does tax-loss harvesting apply to retirement accounts like IRAs or 401(k)s?

No. Since those accounts are already tax-deferred, gains and losses aren’t taxable. Tax-loss harvesting only applies to taxable investment accounts.

3. What are the wash sale rules I need to know about?

The IRS prohibits claiming a loss if you buy the same or a “substantially identical” security within 30 days before or after selling the original investment. The rule is designed to prevent investors from quickly selling at a loss and repurchasing the same asset for tax purposes.

4. Do I need to be wealthy to benefit from tax-loss harvesting?

Not at all. While higher-net-worth investors may see larger dollar impacts, anyone with taxable investments can benefit from reducing taxable income. Even modest tax offsets can make a difference over time.

5. How often should I do tax-loss harvesting?

Some investors review quarterly, while others make it part of the year-end planning process. The timing depends on market activity, portfolio considerations, and overall tax situation. Working with tax planning advisors in Boston can help you decide on the right approach.

6. How does direct indexing expand tax-loss harvesting opportunities?

Direct indexing lets you own individual stocks in an index. That means you can sell underperformers within the portfolio, even if your index hasn’t declined in value, creating more opportunities to harvest losses.

At Sherr Financial Associates (SFA), we integrate tax planning into our approach to providing Boston financial planning services to affluent investors. Our goal is to help you understand strategies like tax-loss harvesting and how you might apply them to your circumstances to improve your overall returns.

If you want to learn more about tax-loss harvesting strategies, contact us today.