The strategy that turns bad news into good news
Market volatility is inevitable. Your investments will sometimes be worth less than you paid for them. Most investors just sit and wait, hoping for a recovery. But there's a smarter approach: tax loss harvesting.
Tax loss harvesting lets you sell investments that are temporarily underwater, lock in the capital loss for tax purposes, and then immediately reinvest in something similar. You stay in the market, but now you have a tax asset that can offset gains or reduce your ordinary income.
It's one of the few "free lunches" in investing: same market exposure, better after-tax returns.
How tax loss harvesting actually works
The basic concept: Sell an investment that's worth less than you paid, realize the loss for tax purposes, then buy something similar to maintain your market exposure.
Here's a real example:
- You bought $100,000 of Stock A
- Market drops, Stock A is now worth $60,000
- You sell Stock A, realizing a $40,000 capital loss
- You immediately buy $60,000 of Stock B (similar exposure)
- You stay invested but now have a $40,000 tax loss to use
The tax benefit:
- Offset capital gains dollar-for-dollar
- Reduce ordinary income by up to $3,000 annually
- Carry forward unused losses indefinitely
For someone in the 37% tax bracket, a $40,000 realized loss could reduce their tax liability by up to $14,800 over time, depending on their overall tax situation.
The three-step process
Step 1: Identify eligible losses Look for investments in taxable accounts that are trading below your original purchase price. This only works in brokerage accounts—not IRAs or 401(k)s.
Step 2: Sell and capture the loss Execute the sale to realize the capital loss. This loss can offset gains elsewhere in your portfolio or reduce your ordinary income.
Step 3: Reinvest immediately Buy a similar but not identical investment to maintain your market exposure and avoid the wash sale rule.
Example replacement strategy:
- Sell VTI (Total Stock Market ETF) → Buy SCHB (similar broad market exposure)
- Sell SPY (S&P 500 ETF) → Buy a different large-cap ETF that tracks a similar but not identical index (for example, SCHX or VTI).
- Sell a tech mutual fund → Buy a tech ETF
The wash sale rule: what you need to avoid
The IRS has a rule designed to prevent abuse of tax loss harvesting: you can't buy back the same or "substantially identical" investment within 31 calendar days before or after selling it.
Note: this applies to any of your accounts, it is not account specific.
What counts as substantially identical:
- The exact same stock or fund
- Very similar funds from the same company
- Options on the same underlying security
What doesn't count:
- Different ETFs tracking similar indices
- Individual stocks in the same sector
- Funds from different companies with similar strategies
Pro tip: You can switch back to your original investment after the 30-day window if you prefer it over the replacement.
When tax loss harvesting makes the most sense
After market declines Volatility creates opportunities. Don't wait until December—harvest losses whenever meaningful opportunities arise.
For high earners The tax savings are most valuable in higher tax brackets, especially when offsetting ordinary income taxed at 37%.
In taxable accounts with significant positions You need meaningful losses (typically $1,000+) to justify the effort and transaction costs.
When you have gains to offset If you've realized capital gains elsewhere, harvested losses can offset them completely.
Near year-end Review your portfolio in November/December to identify final harvesting opportunities before tax year-end.
Common tax loss harvesting mistakes
Violating the wash sale rule Buying back the same investment within 30 days disqualifies the loss. Be patient or choose a different replacement.
Harvesting tiny losses Don't bother with losses under $500-1,000. Transaction costs and complexity aren't worth it.
Getting out of the market The point is to stay invested with similar exposure, not to time the market or go to cash.
Ignoring replacement quality Don't buy a worse investment just for tax purposes. The replacement should provide similar long-term returns.
Overthinking the timing You don't need to harvest losses immediately. But don't wait so long that you miss recovery potential.
Quick Answers: Tax loss harvesting questions
"Can I harvest losses in my IRA or 401(k)?" No. Tax loss harvesting only works in taxable brokerage accounts.
"What if my replacement investment also goes down?" You can harvest that loss too, as long as you don't violate the wash sale rule.
"Is there a limit to how much I can harvest?" No limit on offsetting capital gains. You can offset up to $3,000 of ordinary income annually, with unused losses carried forward.
"Should I harvest small losses?" Generally only if they're $1,000+ to justify the effort and potential transaction costs.
Can Titan help with tax loss harvesting?
Yes. If you're a Titan client, we can:
- Monitor your portfolio for tax loss harvesting opportunities year-round
- Execute harvesting strategies that avoid wash sale violations
- Coordinate with your overall tax strategy to maximize the benefit
- Track your harvested losses to ensure proper utilization
Tax loss harvesting requires ongoing attention and careful execution—it's not a set-and-forget strategy.
Want to turn market volatility into tax savings?
Talk to a Titan advisor to implement a systematic tax loss harvesting strategy that improves your after-tax returns.
About Titan
Titan is a modern Registered Investment Advisor (RIA) helping high-earning professionals navigate complex money decisions. With a dedicated advisor and access to proprietary strategies and alternative investment options, we're your go-to wealth team for everything from RSUs to retirement. Learn more at www.titan.com.
