It’s that time of year when you get gifts from Santa. However, for some individual investors in the USA, the taxman can also give a gift: tax loss harvesting. 

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Tax loss harvesting is when you offset your capital gains on any stock positions which have made money against any capital losses from stocks which have lost money. The idea is to reduce the tax burden from the original capital gain by selling out of profitable positions and reducing the net taxable profit by offsetting and selling unprofitable stocks.  

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However, there are nuances to consider which we highlight below:  

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• It’s not relevant for retirement accounts as you can’t deduct losses in the same way  

• It’s typically used by higher rate tax earners to reduce taxes on short term capital gains (positions held for less than a year) as that’s treated as income tax. Positions held over a year are subjected to a typically lower capital gains tax 

• Short term losses must first be applied to short term gains and the same with long term losses and gains. Excess losses can then be applied to either category 

• It’s best to first focus on short term losses as those can be offset against short term gains which are taxed at a higher rate 

• You must complete the sale of any stock position by the end of the tax year 

• You can also apply up to $3k of realized losses on your stocks against your income tax return and excess losses can be carried over into future years at the same incremental level 

• The “wash sale” rule means you shouldn’t sell and buy a substantially identical security within 30 days of one another or else you can’t offset any losses against gains. A substantially identical security includes another security issued by the same company or a call option on the same security 

• However, you could purchase another security in the same industry or invest in an ETF which tracks the same industry as those may not be considered as substantially identical securities 

• You can also use the same tax loss harvesting strategy for positions in Bonds, ETFs and Mutual Funds although as of now, cryptocurrencies aren’t regulated the same way 

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Nevertheless, the real question is whether employing such tax saving strategies unbalance your overall risk tolerance, investment objectives and portfolio composition. Here are some things to consider: 

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• Make sure that you can immediately reinvest any proceeds into a suitable replacement which fits in with your overall investment strategy 

• Only consider selling investments where the fundamentals, technical and/or sentiment is negative, and it no longer fits within your investment strategy 

• It’s best to think about tax loss harvesting strategies when you are looking to rebalance your portfolio. If you check your portfolio every 3 months, you will be more aware of how your positions have moved over the course of the tax year  

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For example, this UHNWI investor has a diversified portfolio with ~60% in equities and has ~19% exposure to the Financials sector. 

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When looking at tax loss harvesting strategies, they could consider closing their BNP Paribas position which has generated a P&L of $132,429 and offsetting some of this gain by selling their Citigroup position which has made a loss of -$63,405. However, in doing so, they may alter the balance of their portfolio as the BNP position is 6.1% of their total portfolio and this may upset the equity and sector mix that they are currently comfortable with. 

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Once you have decided which instrument to sell to offset a gain, you need to look at the actual cost basis. For example, this mass affluent investor bought Build-A-Bear over the year and has generated a profit of $4,305. Against this, they have a running loss with Microsoft at -$2,045. Note the current Microsoft share price is $238.73. 

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However, when they look at their transactions, they bought Microsoft twice over the year. On reflection, they may prefer to only sell the 30 Microsoft shares bought on 1 Feb 2022 at $308.76 as opposed to also selling the 15 shares bought on 3 Oct 2022 at $240.74 as the former has a higher cost basis. This doesn’t offset as much of the Build-A-Bear profit but there may be other reasons to hold onto at least some of the Microsoft position that fit within their overall investment strategy. 

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In all cases, it is best to consult with a specialist before deciding on whether to employ tax loss harvesting strategies when you come to rebalance your portfolio. 

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** Please note, you should always clarify your tax position with your accountant or financial advisor and this article is for educational purposes only.  

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