Stocks are volatile, and losses are inevitable. But don't worry—there's a silver lining. Tax Loss Harvesting is a smart strategy that can turn those losses into opportunities to boost your portfolio.

What is tax-loss harvesting?

Imagine your investment portfolio as a thriving garden. Tax-loss harvesting is like pulling out the weeds (underperforming stocks) to make space for new plants (promising investments). This process ensures a healthier and more balanced garden (portfolio) over time. And those weeds? You've tossed them in a deluxe, dual-chamber, rapid composter, turning them into nutrients that will nourish your garden in the future. In essence, you're clearing out and transforming the losses into something beneficial for the future. (Excuse the gardening metaphor - but you know, tax-loss harvesting - the topic was asking for it.)

Why should I care about tax-loss harvesting?

Tax-loss harvesting turns a setback into an opportunity. Given the volatile nature of stocks, some will inevitably lose value. By maintaining a diversified portfolio aligned with your goals and proactively selling some of the underperformers, you can start banking valuable tax assets. These assets can help you reduce your tax bill both this year and in the future.

The key to successful tax loss harvesting is doing it consistently and carefully without breaking any other tax rules. There are many factors to consider: determining the right time to sell at a loss, what to buy with those proceeds, and ensuring your portfolio remains on track to meet your investment goals.

How does tax-loss harvesting work?

Suppose you buy a stock for $100, and a month later it’s worth only $80. If you sell it at that point, you can claim a $20 loss on your tax return. Over time, these harvested tax losses add up, acting like a buffer against future taxable events.

The proceeds from the sale are oftentimes used to purchase a similar security to stay invested in the market, or other stocks to rebalance the portfolio.

When you incur capital gains – for example, from selling shares or rebalancing your portfolio – you can use these harvested losses to offset those gains and reduce your tax bill. It's a smart way to make the most of a down market and keep more of your hard-earned money.

Should I tax-loss harvest if I don’t have any capital gains?

Absolutely! And here’s why:

1. Offset ordinary income: Tax-loss harvesting isn’t just about offsetting capital gains; it can also reduce your ordinary income. Each year, you can use up to $3,000 of your harvested losses to offset ordinary income, like your salary or other earnings. For those in the highest tax brackets, this can mean substantial savings. For instance, if you’re in the highest tax bracket, a $3,000 offset might result in more than $1,500 in real savings – that’s enough for a nice weekend getaway (or the gadget upgrade your teenager has been negotiating for)

2. Offset future capital gains: Harvested losses can be carried forward, like adding to a rainy day fund. Even if you don’t have capital gains this year, you can use these losses in the future. When the time comes to realize capital gains, these harvested losses can help make the tax hit much more manageable.

When should I tax-loss harvest?

Tax-loss harvesting has been a tried-and-true strategy for decades. Traditionally, investors would wait until December to harvest their tax losses and lock in valuable deductions before the new year.

However, with advancements in automation, the game has changed. The modern best practice is to harvest losses throughout the year, taking advantage of market volatility whenever it occurs. Every time there’s a market swing, there’s a potential opportunity to harvest losses and enhance your portfolio's tax efficiency. This is just one more reason we love leveraging technology to help improve your finances.

What’s the catch?

While tax-loss harvesting is a powerful tool, there’s one important rule to keep in mind: the Wash Sale Rule. If you sell a stock at a loss and then buy the same stock (or a substantially identical one) within 30 days before or after the sale (a 61-day window), the loss is disallowed for tax purposes. To avoid this, investors typically sell the losing stock and replace it with a different one – or have this risk managed by a tech solution like Arta (more on that below!).

Wash sales can be a real setback. If you inadvertently trigger a wash sale, you can’t use the tax loss in the current year. Instead, the loss gets added to the cost basis of the new stock, and the holding period resets to the original purchase date. This essentially nullifies the immediate tax benefit of the loss.

This is a significant drawback because the benefits of tax-loss harvesting compound over time. It’s crucial to bank these tax assets now and let them work for you.

In a worst-case scenario, if you sell at a loss and repurchase the same shares within your (or your spouse’s) IRA, the loss is permanently disallowed. So, it’s essential to stay vigilant and avoid these pitfalls to fully reap the compound growth that tax-loss harvesting produces.

So what’s the next step?

If you’ve read this far, you’re likely wondering how to stay on top of tax-loss harvesting without breaking any tax rules and banking those losses for future use. Well, it’s not quite as simple as “we have an app for that”—but with Arta, it’s pretty close.

Arta automates tax-loss harvesting using advanced algorithms to optimize your tax losses and navigate complex tax rules, like wash sales, all while keeping your investment goals in sight.

In Arta’s direct indexing portfolios, tax-loss harvesting becomes effortless. Arta manages your tax losses, monitors the wash sale window, and identifies the best opportunities to repurchase stocks. This enables you to capture the maximum tax benefit and maintain a well-aligned portfolio–right on track to meet your investment goals. You can also learn more about direct indexing on the website.

Tax-loss harvesting is ideally suited for automation. By meticulously handling all the intricate details and potential pitfalls – with an added bonus that computers never sleep and don’t take vacations, Arta can add tremendous value to your investment strategy.

And to wrap back to our earlier metaphor, think of Arta as your expert gardener. With our advanced tools and technology, we help you pull the weeds and cultivate a healthier, more vibrant investment garden. (And obviously we’ve got the most advanced composter!) Head over to Arta and see how you can better tend to your portfolio.

See specific disclosures about tax-loss harvesting here.