When the market takes a downturn, it’s easy to feel discouraged. Seeing your portfolio in the red can be frustrating, even if you know investing is a long-term game. But here’s a silver lining: market losses can create an opportunity to reduce your tax bill through a strategy called tax loss harvesting.

What Is Tax Loss Harvesting, and Why Should You Care?

Tax loss harvesting is the process of selling investments at a loss to offset taxable gains elsewhere in your portfolio. This can help lower your overall tax liability, potentially saving you money when it’s time to file your taxes. And if you don’t have enough gains to offset, you can use up to $3,000 of capital losses per year to reduce your ordinary income (or $1,500 if married filing separately), carrying forward any excess losses to future years.

How Does It Work in Practice?

Here’s a more detailed breakdown of tax loss harvesting in action:

1. Identify a Losing Investment – Review your portfolio to find stocks, mutual funds, or ETFs that have declined in value since you purchased them.
2. Choose the Right Lots to Sell – If you’ve purchased the same security at different times and prices, you have multiple ‘lots’ with different cost bases. Instead of selling shares randomly, you can use the Specific Identification (Spec ID) cost basis method to strategically select the shares with the highest losses.
3. Sell the Investment to Realize the Loss – Execute the sale of the selected lot(s) to lock in a capital loss, which can then be used to offset capital gains or ordinary income.
4. Reinvest in a Similar (but Not Identical) Investment – To maintain your desired asset allocation and avoid being out of the market, reinvest the proceeds in a similar security.
5. Track Your Cost Basis for Future Sales – Using Spec ID also helps you keep a more strategic record of remaining lots.

The Wash Sale Rule: Avoiding a Costly Mistake

The IRS doesn’t let investors sell a security at a loss and immediately repurchase the same (or a ‘substantially identical’) security within 30 days before or after the sale. This is known as the wash sale rule. If triggered, the tax benefit is disallowed, and the loss is added to the cost basis of the new investment.

Wash Sales Across Accounts

The wash sale rule applies across all your accounts, including IRAs and retirement plans. If you sell a stock at a loss in your taxable brokerage account but repurchase the same stock inside your IRA within the wash sale window, the IRS will still disallow the loss.

Dividend Reinvestment Plans (DRIPs) and Wash Sales

Another easy-to-miss trigger for the wash sale rule comes from automatic dividend reinvestments. If you sell a security at a loss but receive a dividend that automatically reinvests in the same stock within the 30-day window, it can partially or fully disallow your loss.

When Tax Loss Harvesting Makes Sense

This strategy can be particularly useful if:

• You have large capital gains from selling winning investments or other assets like real estate.
• You want to reduce taxable income (up to the $3,000 annual limit).
• You plan to hold investments long-term and can replace losses with similar assets to stay invested.

When It Doesn’t Make Sense

Tax loss harvesting isn’t always a slam dunk. It may not be beneficial if:

• Your tax rate in retirement will be lower, making deferring gains more valuable.
• You’re in a low tax bracket and already paying little to no capital gains tax.
• You’re selling high-quality investments purely for tax reasons, which could disrupt your strategy.
• You have limited gains to offset, meaning additional losses may not provide immediate benefits.
• You hold investments in tax-advantaged accounts, like IRAs or 401(k)s, where losses provide no tax benefit.

A Year-Round Strategy, Not Just Year-End

While tax loss harvesting is most commonly considered in December for year-end tax planning, it can be done anytime market conditions present opportunities. A disciplined, year-round approach can maximize tax savings without forcing rushed decisions.

Wrapping It Up

Tax loss harvesting is a smart way to make the best out of a down market, turning temporary setbacks into long-term tax advantages. But it’s not a one-size-fits-all strategy. Understanding the nuances—especially the wash sale rule and the impact of dividend reinvestments—is critical to executing it effectively.

At Suttle Crossland Wealth Advisors, we help investors navigate market volatility with a focus on long-term success. Want to see if tax loss harvesting makes sense for you? Let’s talk.