Tax Loss Harvest Time: Making the Most of Your Losses

Originally published November 2021

Updated November 2023

Ah, autumn! The harvest season! Right now, images of pumpkins, squashes, fall fruits, and overflowing cornucopias abound. But what does this have to do with investing? I’m glad you asked.

This fall, as thoughts turn to wrapping up for the year’s end, consider the idea of Tax Loss Harvesting. If you have investments that have lost value, you might be able to use those losses for your benefit.

Please allow me to explain.

Gains and Losses

When you buy an investment, the amount you pay is your cost basis (sometimes called tax basis).

If the value of your investment increases to a level above your cost basis, you have an unrealized gain.

If the value of your investment decreases to a level below your cost basis, you have an unrealized loss.

“If you continue to own the investment, there are no tax consequences because all gains or losses are unrealized — they only exist on paper.”

But if you sell an investment with an unrealized gain — that is, you sell it for more than your cost basis — you have now realized the gain and generated a tax liability.

Read: When Do My Investments Get Taxed?

Netting Out

Many investors simply look at their annual Form 1099, shrug their shoulders, and pay taxes on their realized gains, unaware that they might have avoided those taxes with a bit of planning.

“The U.S. Tax Code allows an investor to net realized losses against realized gains in any given tax year.”

For example, say you owned Investment A, which you sold, realizing a gain of $100. Let’s also say you owned Investment Z, which you sold for a realized loss of $100.

You can net your realized loss against your realized gain to zero out the tax bill associated with the $100 gain on Investment A.

Now, let’s take it a step further.

Harvesting

Let’s say that your normal investing activities during the year lead to the following:

If you do nothing, you might end up paying as much as $1,400 in taxes on your net realized gain.^[1]

But what about those unrealized losses? What if you converted them from unrealized to realized?

“You could sell the investments with unrealized losses, harvesting them to offset your realized gain.”

 Now, the math is more favorable.

If you can harvest all of your unrealized losses, your tax bill could be lowered to as little as $400 — a $1,000 savings!^[2]

Considerations

Before you crack open your laptop to hunt for unrealized losses, a few notes of caution.

If you sell an investment and then turn around and repurchase that same investment (or a substantially similar one) within 30 days of the original date of sale, either before or after the sale, the sale is deemed a Wash Sale, and the deduction for the loss will be deferred.

So be sure you have a substantially different investment in mind or are willing to let cash sit around for 31 calendar days before re-entering the original investment.

And speaking of letting cash sit around, know that you may miss a market rally (or correction) while you are waiting to rebuy positions that you used to harvest losses. In other words, be prepared for some FOMO.

Lastly, consider transaction costs.

“If you pay trade commissions, those costs may outstrip your tax savings.”

You may pay a trade commission when you sell and another commission when you buy.

Harvesting unrealized losses to offset realized gains can be a handy tool for managing your annual tax bill. But be sure that you are also considering factors like opportunity cost and trade costs before you jump in.

Can you benefit from services like Tax Loss Harvesting and other elements of Wealth Management?

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Baird does not provide tax or legal advice. Please consult your legal or tax professional for specific information.

While Baird does not offer tax or legal advice, our Financial Advisors regularly work with client's attorneys and tax professionals to help ensure that all phases of wealth management are addressed.

^[1] Assuming a tax rate of 20%: $10,000 of realized gains - $3,000 of realized losses = $7,000 net gain x 20% = $1,400

^[2] Assuming a tax rate of 20%: $10,000 of realized gains - $8,000 of realized losses = $2,000 net gain x 20% = $400

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