Tax-Loss Harvesting – 2022 Edition

Patrick Cote |

BY: PATRICK COTE

Tax loss harvesting is the practice of selling an asset in your taxable investment account that has experienced a loss and replacing it with a similar asset to maintain the overall allocation within your portfolio. By realizing, or “harvesting,” the loss you are able to reduce taxes by offsetting capital gains.

With what turned out to be great timing, we wrote about this technique in May 2020.  People who harvested their tax losses at that time were able to benefit from a tax perspective when the markets rebounded sharply for the rest of 2020 and into 2021.  While we don’t claim to have any special ability to time the markets – it is generally useful to do tax loss harvesting after the market drops.  Since many investments had significant declines in 2022, we now have another good window for this technique.

Tax loss harvesting involves selling investments with unrealized losses, then turning around and buying something similar but not identical to keep the investment exposure.  It only applies to taxable investment accounts, not retirement accounts, like IRAs or 401Ks.

Any losses realized via tax loss harvesting are used to offset taxable capital gains for you that year (including distributions from mutual funds).  If there are more capital losses than gains, or if you don’t have any gains in that year, you can deduct $3,000 (married) or $1,500 (single) from your income.  The losses carry forward indefinitely into the future.

As you might guess, there are some catches – it can become quite complicated and if not done correctly, the IRS might disallow the losses due to wash sale rules.  This can happen if the same security was bought during the 30 days before or after the sales transaction across any of your accounts (or your spousal accounts).

Ideally, you would be able to buy the exact same security after selling it for tax loss purposes, in order to continue to be invested – unfortunately that is not permitted.  For example, if you bought a Vanguard S&P 500 index fund at the beginning of 2022, you might be sitting on losses of ~20% now.  You would ideally sell it to get the tax loss, however you would want to continue to have exposure to the S&P 500 index to make sure you do not miss out on any market rebound.  The wash sale rule kicks in if you buy the same Vanguard S&P index fund 30 days before or after the sales transaction.  Importantly, the wash sale rule would apply even if you bought another S&P 500 index fund, such as a Fidelity S&P 500 index fund, since the IRS could argue it is the same thing from an investment perspective.  In order to maintain the investment exposure, it is important to buy something similar but not identical, such as an actively managed US large cap fund or a broader US equity index fund (not the S&P 500).

Another area that can trip people up is that the wash sale rule applies across accounts, including spousal accounts.  This means that purchases in an IRA, 401K or trust account, even for your spouse, can disqualify the loss if done 30 days before or after the sale.

In practice, many DIY investors and investment advisors do not take advantage of the tax loss harvesting opportunities because they are often challenging to execute.  The investment tools available, even for the pros, generally do not automate the process, so it can involve a lot of manual work, particularly when people have multiple investment accounts.

If you think you might benefit from tax loss harvesting this year and would like help, please feel free to reach out to us.