Tax-loss harvesting explained: the silver lining when some stocks go down

Tax-loss harvesting is a way to minimize your capital gains tax bill at the end of each year. At Plenty, we help you tax loss harvest automatically to help optimize your returns.

Benjamin Franklin once said, “In this world, nothing is certain except death and taxes”.

In the investing world, nothing is certain except the market going up and down – and also taxes.

The good news about taxes — bet you never thought you’d see good news and taxes in the same sentence — is that you can use something called tax-loss harvesting to not only lower your taxes but also optimize your investment portfolio. It’s a strategy that the wealthiest investors have been using for decades. The secret’s out, and it’s not as complicated as you’d think.

TL;DR: Tax-loss harvesting

1. It reduces your taxes by using losses to offset gains.

   
   

2. It can boost your after-tax returns by roughly 2-4%.

   
   

3. Each year, the Internal Revenue Service (IRS) allows up to $3,000 of capital losses to reduce your taxable income.

Ok, but what is tax-loss harvesting?

We’ve already talked about how the rich invest using a strategy called direct indexing, and one of the superpowers of direct indexing is finding the silver lining when some stocks go down.

Even the most successful investors know that not every investment is a winner all the time. Stocks can go up and down, and even great companies may have a tough week, month, or quarter – which can create a tax opportunity. Here’s how it works:

1. You sell a stock that went down

   
   

2. You find another stock that went up and sell it; creating a gain

   
   

3. You use the loss to cancel out the gain. Now you don’t pay tax on the stock that went up and can put that money back into the market. You’ve now saved on taxes and have more tax-free money to invest with.

What if you don’t have gains yet to conduct tax loss harvesting?

If you don’t have any gains from investments, you can still use up to $3,000 of losses every year to reduce your taxable income. As of now, there is no expiration for the number of years you can carry over the losses.

And did you know that tax-loss harvesting can actually boost your after-tax returns by roughly 2-4%?

That’s right! The wealthy are always looking for ways to minimize taxes now and in the future. Traditionally, they’ve been the only ones with access to these strategies because they could:

1. Afford the high investing minimums required (like $250k+)

   
   

2. Afford to actually buy whole shares of individual stocks (unlike the rest of us who could only afford ETFs)

   
   

3. Afford wealth managers to do everything for them (buying, selling, monitoring for tax breaks, rebalancing their portfolios, etc). 

Well, it’s 2023, and about time that everyone has access to the best ways to build wealth. With early access to Plenty and just a $100 minimum deposit, you’ll get a higher-earning and tax-efficient way to invest. In fact, we estimate that with tax-loss harvesting, you can add roughly an extra 2-4% on top of your after-tax returns. That means lower taxes and more money in your pocket.  

Tax-loss harvesting almost sounds too good to be true

The wealthiest investors have been using this strategy for a while, and it may come as a surprise to some of you, but it IS legal. The IRS is fine with tax-loss harvesting and you can do it too as long as you follow their rules. Look out for this common one:

‘Wash sale’ rule

Basically, if you sell something at a loss and replace it with something pretty much identical within 30 days, that’s a “wash sale”. The IRS doesn’t like it. So they won’t let you claim that loss to offset gains.

Most tax experts would recommend you consult a professional before diving into tax-loss harvesting. Alternatively, advanced robo-advisors like Plenty use technology to offer automatic tax-loss harvesting services. This way, you don’t need to stress about following complicated tax rules.

When you’re investing at scale (like in hundreds of stocks), it's pretty complicated to keep track of all these things, but it's the perfect job for a machine. This is where Plenty comes in to do the heavy lifting for you.

When should you care about tax-loss harvesting? 

Tax-loss harvesting only benefits you if you’re required to pay capital gains tax (now or in the future). So if your individual income is over $45k (or over $84k if filing jointly), then you can use it to reduce your taxes.

It’s most effective for taxable account types (including 401k or IRAs where you don't pay taxes now, but you will pay taxes when you withdraw). It’s not as useful for after-tax or accounts with tax advantages (like a Roth IRA, Roth 401k, or 529c).

So, tax-loss harvesting can be a savvy way to save some money on your taxes. It’s kind of like playing chess with Uncle Sam - you strategically sell off investments at a loss and offset them against gains from other investments.

But keep in mind: that tax laws can be tricky, so if you're thinking of tax-loss harvesting, you want to make sure that it's done right so that it pays off. 

If you're a big reader like we are, you might want to learn more! Here are a few more references we like:

Tax-loss harvesting | Capital gains and lower taxes | Fidelity

How Tax-Loss Harvesting Works for Average Investors

About Plenty

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The information provided herein is for general informational purposes only and should not be considered individualized recommendations or personalized investment advice. The type of strategies mentioned may not be suitable for everyone. Each investor should evaluate an investment strategy based on their unique circumstances before making any investment decisions.

Investing involves risk, including risk of loss. Past performance may not be indicative of future results. Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. We recommend that you consult a tax professional before taking action.

Plenty does not provide legal or tax advice. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic, and geo-political conditions