Educational content only. This article is for informational purposes and does not constitute personalized financial, tax, or investment advice. Consult a qualified professional for guidance specific to your situation.
TL;DR
Delays taxes, doesn't eliminate: Your cost basis resets lower after harvesting, so you'll owe more later when you sell
Easy to DIY: Sell the losing fund, immediately buy a similar-but-different one — and respect the 30-day wash sale rule
Not worth paying for: Robo-advisor management fees eat what you save; do it yourself during market dips if at all
Have a complex tax situation with gains and losses across multiple accounts? Book a free 15-min call and I can help you map out a tax-efficient strategy.
Tax loss harvesting is a strategy that you can use to reduce your tax liability. Robo-advisors use it as one of their biggest selling points, and I don't think it's worth it for several reasons*:
Your ability to tax loss harvest is limited—the market usually trades at all-time highs
Tax loss harvesting delays taxes instead of eliminating them
The robo-advisor management fee will eat away what you save pretty quickly
Also, it's easy to DIY.
* Unless you're in a very high marginal tax bracket that's meaningfully higher than your long-term capital gains tax, though it's still not worth paying for.
Tax loss harvesting involves selling an investment that you've purchased at a loss and using the proceeds from the sale to purchase a "similar" investment. The IRS then allows you to deduct the loss from your income in the present tax year (up to a maximum of $3K). However, because the new purchase is resetting your cost basis, tax loss harvesting is a strategy that delays taxes, not one that eliminates taxes.
Example: Tax Loss Harvesting in Action
January 2020: You invest $10K into VTI. In 3 months, US markets plummet 30%.
VTI is now worth $7K, so you sell it at a loss of $3K. But you immediatelly buy SCHB for $7K, a similar ETF.
Tax benefit: You get to write-off $3,000 from your 2020 taxes, which means it probably saved between $300-600.
By March 2024, your $7K SCHB investment has grown to $14K and you want to sell. The catch: Your cost basis is now $7K (not your original $10K).
You now owe long-term capital gains tax on the full $7K profit. This means you're paying tax on the $3K loss you previously harvested.
At a typical 15% long-term capital gains rate, that's an extra $450 in taxes
Bottom line: Depending on your tax brackets then vs. now, this could cost you more money in the long run
Important Consideration
Remember that tax loss harvesting doesn't eliminate taxes—it only defers them. The benefit comes from the time value of money and potentially taking advantage of different tax rates at different times in your life.
How do I DIY tax loss harvesting?
Step-by-Step Guide
The White Coat Investor has great step-by-step instructions on how to tax loss harvest. Their guide covers the specific actions to take, timing considerations, and how to avoid the wash sale rule.
• Be aware of the wash sale rule (don't buy a "substantially identical" security within 30 days before or after the sale)
• Choose replacement funds that are similar but track different indexes
• Consider transaction costs and expense ratios when selecting replacement investments
• Keep good records of all transactions for tax reporting
• Remember that the strategy is most beneficial during market downturns
Summary: Is Tax Loss Harvesting Worth It?
While tax loss harvesting can provide short-term tax benefits, it's important to consider:
Opportunities for tax loss harvesting are limited since markets typically trend upward
The strategy only defers taxes rather than eliminating them
Management fees from robo-advisors offering this service often outweigh the benefits
DIY tax loss harvesting is relatively simple and can be done without paying advisor fees
Bottom line: Tax loss harvesting can be worth doing yourself during market downturns, but probably isn't worth paying a management fee for, especially if you're not in a high tax bracket.
Have a complex tax situation with gains and losses across multiple accounts?
I can help you identify harvesting opportunities and build a tax-efficient strategy for your situation. One-time consultation, no ongoing fees.