It’s always a good habit to do some tax-loss harvesting (TLH) before year end, especially in years when the stock market is down significantly.
This is primarily because you can use investment (capital) losses to offset any capital gains of similar assets; and also use the $3,000 income offset provision to legally lower your income tax liability if your capital losses exceed your gains.
A lot of people with a reasonable amount of earned income could easily save hundreds of dollars with TLH and some simple portfolio actions. Here is the three-step process I follow as part of my end-of-year tax planning to achieve this. It ended lowering my taxable by up to $2,500.
Step 1 : Figure out your Realized Capital Gains or Losses to Date
The first step is to figure out your realized gains or losses to determine where you stand and how much of your investments you may need to sell to take advantage of tax-loss harvesting. If you own funds, they auto buy and sell through out the year so you may have capital gains you don’t even realize.
Fortunately most good brokerages provide a summary of realized gains as of the current date. Remember to only focus on taxable brokerages accounts and not retirement (e..g IRA or 401K) accounts since there is no capital gains or losses due on these accounts.
For example you can see this on E*Trade and Fidelity screenshots below if you go to their tax center(s) and find YTD tax reports. I recommend doing this on your desktop as you only get limited views and details on mobile devices.
For the purposes of determining your tax loss harvesting position (Steps 1 and 3), you just need to track gains and losses at the broker or portfolio level. For portfolio actions (Step 2), you will need to track and determine which individual stocks and investments you want to sell.
Once you collect all the information from the various brokerages, you can summarize it in a simple table as shown below.
It’s important to separate the Short-Term and Long-Term gains as you want to ensure you offset shot term losses first given the higher tax rates (essentially treated like ordinary income) that apply to them.
Based on the table above, my goal is to offset over $25,000 of capital gains! Mainly from selling my Apple stock and some passively generated gains from Fidelity stock funds. I also want to try and generate $3,000 more in losses to offset this against my taxable income.
Step 2 : Decide What Stocks or Funds to Sell
Now that you know where you stand as of a given date, you will need to figure out what to sell before year end (Dec 31st) to take advantage of tax-loss harvesting. This will vary by investor and I am not going to provide specific investment guidance here, but here is my general order of selling
- Dump “loser” stocks with a capital loss. Prioritize the biggest losers and ones I don’t think are going to make a meaningful recovery. Zscaler (ZS) is an example of a stock like this.
- Sell stocks with a capital loss, even if I like them. I can buy them back after 30 days, to avoid wash sale, if I believe in their long term potential. Amazon (AMZN) is an example of this for me.
- You can also sell Crypto, ETFS and Mutual funds to book a capital loss (or realize a gain). So don’t forget about these investment assets.
The whole process above is iterative and may take a few days or weeks to execute – so don’t wait till the last trading day of year to execute your tax loss harvesting strategy.
Below is how I plan and track my investment sales to meet by tax loss target. You can see that I want my losses to offset the realized gains noted in Step 1. I also keep comments to track my thoughts and potential actions.
You can see to date, that I have now sold stocks to generate $24,774 of capital losses. I still have two more stocks to sell to get to my target of $28,000. This is to allow me to offset gains and take the $3,000 capital loss income tax deduction.
Step 3 : Re-calculate your realized gains before December 31st.
So the final step is basically a repeat of Step 1, which is to get a final view before year end of where your capital gains position stands.
Remember that you want to offset your gains with losses (where applicable) and if you are in a higher income tax bracket, you want to potentially take $3,000 of extra capital losses – from loser stocks you would sell anyway – to offset against your taxable income.
This could given you a 37% discount of your losses by reducing your taxable income if in the highest tax bracket. If you are subject to the net investment income tax (NIIT), which is 3.8%, your effective tax rate could be as high as 40.8%. When state and local income taxes are also taken into consideration, the overall tax rate could be even higher. So the benefits of TLH increase the more your taxable income does.
The table below shows the final place I ended up at after completing all my selling activities.
I wasn’t able to completely offset my short term gains, but will be able to apply the excess long term losses against that. This leaves me with around $2,500 to offset against my taxable income.
I want to reiterate that while I sequentially showed the three main steps for my TLH strategy, they are iterative and I will go back and forth between steps 2 and 3 until I meet my target loss.
Also remember if you don’t have any gains for the current years to offset, it can still be beneficial to harvest your losses (and sell your duds) because they can be applied to offset future income or gains.
And if you have more capital losses than gains, you can use up to $3,000 per year to offset your ordinary income for federal income taxes and carry over any remaining losses to future tax years.
If you want the full spreadsheet I used for my calculations, leave a comment below and I’ll email you instructions to download it.