Tax Loss Harvesting Explained - How To Add 14% To Your Portfolio

[00:00] Tax loss harvesting may sound fancy and complicated,

[00:04] have a better understanding of it after watching

[00:07] Here we’ll explore what tax loss harvesting

[00:12] rules, limits, and deadlines involved, examples,

[00:17] in your portfolio.

[00:18] What Is Tax Loss Harvesting?

[00:20] Tax loss harvesting just refers to selling

[00:25] Simple as that.

[00:26] Specifically, we’re talking about selling

[00:30] at the time of sale in order to offset realized

[00:35] have any realized gains) for that year.

[00:37] If used to offset realized capital gains,

[00:41] the former of which are taxed at higher rates.

[00:43] In other words, realized losses can be used

[00:48] the year.

[00:49] We call this sale “harvesting” the loss,

[00:53] Tax loss harvesting to offset that year’s

[00:58] the calendar year, so the deadline is December

[01:01] Naturally, this encourages many to employ

[01:05] end of the year to harvest any losses, but

[01:10] your position in a security has an unrealized

[01:13] Day traders will use this as a tool to offset

[01:17] If the long term investor is simply holding

[01:22] losses can reduce their income tax liability.

[01:24] So far tax loss harvesting sounds like a great

[01:28] Unfortunately there are some limits and rules

[01:31] First, if the long term investor mentioned

[01:35] to harvest losses to reduce their taxable

[01:40] of $3,000 per year if single or married filing

[01:44] That is, if your realized net loss on your

[01:48] you can only deduct up to $3,000 from your

[01:53] also carry forward the unused loss of $2,000

[01:58] Secondly, there’s an important tax loss

[02:02] wash sale rule that prohibits investors from

[02:08] The rule states that the investor wishing

[02:13] identical” security within 30 days on either

[02:18] a “wash sale” which invalidates the harvesting

[02:22] This rule applies across all your investment

[02:25] It also applies to reinvested dividends and

[02:31] wanting to harvest losses, you’d want to

[02:33] After you sell to harvest a loss, you can

[02:38] or hold cash for 31 days and then buy your

[02:43] While a bit more complicated, the former may

[02:47] only a handful of great days for the stock

[02:53] and those days could very well occur during

[02:57] But of course, in true IRS fashion, they have

[03:02] a “substantially identical” security,

[03:07] disagreement on whether or not two funds from

[03:11] index would be considered “substantially

[03:14] Luckily, we can usually avoid that anyway

[03:19] the same exposure we’re after.

[03:21] Also remember that tax loss harvesting is

[03:25] as the IRS does not tax growth in retirement

[03:30] have a taxable account, you don’t need to

[03:33] Now let’s check out some examples to see

[03:37] The numbers for gains and losses are made

[03:40] The tax brackets and harvesting limits are

[03:44] Consult your tax professional.

[03:45] I’ve included the cursory math on the screen

[03:49] First let’s look at an example of offsetting

[03:53] to simply reduce the capital gains tax liability.

[03:56] Suppose Sarah has sold a position during the

[04:01] of $2,000 and is in the 24% tax bracket.

[04:04] Since short-term capital gains are taxed at

[04:08] pay $480 in taxes on those gains at tax time.

[04:12] Before the end of the year, she notices another

[04:17] By harvesting that loss, she can now offset

[04:22] capital gain is reduced to $500, on which

[04:29] of 75%.

[04:30] Remember short-term capital gains apply to

[04:34] they’re characterized as long-term capital

[04:37] Long-term capital gains are taxed at lower

[04:39] Specifically, if Sarah’s previous position

[04:43] 15% in taxes on it instead of 24%.

[04:46] If she deployed the same tax loss harvesting

[04:50] gains tax liability from $300 to $75, a reduction

[04:55] This illustrates that tax loss harvesting

[04:59] is still useful for long-term gains as well.

[05:02] Now let’s look at an example where the net

[05:06] Assume Ashley has sold a position during the

[05:10] of $2,000 and later notices before the end

[05:15] of the same amount, $2,000.

[05:18] Harvesting the loss offsets the gain in full

[05:23] for the year.

[05:24] For the next example, we’ll look at a situation

[05:29] gain.

[05:30] Assume Ashley’s unrealized loss from the

[05:35] and she still has the realized long-term gain

[05:38] She can offset that gain in full and then

[05:44] reduce her taxable income.

[05:46] If her long-term capital gains rate and effective

[05:51] in capital gains taxes and $150 in income

[05:57] Lastly, we’ll look at an example with a

[06:03] limit and zero realized gains.

[06:05] If you subscribe to the Boglehead philosophy

[06:09] the most likely situation you’ll find yourself

[06:14] Pretend Patrick is a long-term investor who

[06:19] his taxable brokerage account of index funds

[06:24] realize gains until retirement.

[06:26] While his account value has obviously grown

[06:32] groups of shares bought earlier in the year)

[06:38] markets faltered during the year, and he has

[06:43] any of his positions.

[06:44] Remember we can use tax loss harvesting to

[06:50] can book that $5,000 loss, reduce his taxable

[06:56] forward that extra $2,000 in unused losses

[07:02] I’ve seen many ask if tax loss harvesting

[07:07] time and effort required, to which I’d reply:

[07:10] First, it’s a very small amount of time

[07:14] year.

[07:15] Secondly, yes a $3,000 tax write-off each

[07:20] Lastly, we showed earlier how tax loss harvesting

[07:26] marginal tax rate increases.

[07:27] A study from First Quadrant estimated that

[07:33] final portfolio value compared to one that

[07:37] For a $1 million portfolio, that would be

[07:42] So it sounds like tax loss harvesting is always

[07:46] Well, not quite.

[07:48] Recognize that in selling at a loss and re-entering

[07:52] now lowered your cost basis from what it was

[07:57] taxed later in the future.

[07:58] Granted, those greater gains won’t be taxed

[08:02] yourself an interest-free loan, and we’d

[08:07] little to no income for most people.

[08:09] But in that sense, it’s important to note

[08:14] not avoided them entirely.

[08:15] So an obvious situation when it would not

[08:20] be taxed on gains in the first place, which

[08:25] to avoid capital gains taxes altogether.

[08:28] This only applies to long-term capital gains,

[08:32] avoid if your annual income is below about

[08:37] Now let's look at the steps for how to tax

[08:40] 1 - Turn off dividend reinvestment.

[08:42] Make sure you haven’t bought any shares

[08:46] 30 days.

[08:47] 2 - Sell the position at a loss.

[08:49] 3 - Buy an alternative replacement fund (examples

[08:54] the original position.

[08:56] 4 - Turn dividend reinvestment back on unless

[09:01] Here is a non-exhaustive list of groups of

[09:06] out that we can be sure would not be classified

[09:11] I'm not going to go through them one by one

[09:15] link in the description to sift through this

[09:18] In conclusion, tax loss harvesting – selling

[09:24] taxable income – may be a useful part of

[09:27] The tax savings from harvesting losses increase

[09:33] Plan ahead to ensure your tax loss harvesting

[09:37] Follow the steps above and decide whether

[09:42] for 31 days.

[09:43] For those using M1 Finance, note that while

[09:48] harvest tax losses for you, their tax optimization

[09:53] losses first anytime you sell shares.

[09:56] How do you approach tax loss harvesting in

[09:59] Let me know in the comments.

[10:01] Thanks for watching.