What is 'Tax Gain/Loss Harvesting'

Tax gain/loss harvesting is a strategy of selling securities at a loss to offset a capital gains tax liability. It is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income tax rates than long-term capital gains, though it is also used for long-term capital gains.

BREAKING DOWN 'Tax Gain/Loss Harvesting'

Tax gain/loss harvesting is also known as "tax-loss selling." Usually, this strategy is implemented near the end of the calendar year but may be completed at anytime throughout a given tax year. With tax-loss harvesting, an investment that has an unrealized loss is sold, thus realizing the loss, allowing it to be credited against any realized gains that occurred in the portfolio. The asset sold is then replaced with a very similar asset to maintain the portfolio's asset allocation and expected risk and return levels.

For many investors, tax gain/loss harvesting is the single most important tool for reducing taxes now and in the future. If properly applied, it can save you taxes and help you diversify your portfolio in ways you may not have considered. Although it cannot restore your losses, it can certainly soften the blow. For example, a loss in the value of Security A could be sold to offset the increase in value of Security B, thus eliminating the capital gains tax liability of Security B.

Tax-Loss Harvesting Example

Assume an investor is in the highest marginal tax rate bracket, which as of 2016 is 39.6%. Investments held for over 365 days and sold have their capital gains taxed at the long-term capital gains rate, which for an investor in this marginal tax rate bracket is 20%. Investments held for less than 365 days and sold have their capital gains taxed at the short-term capital gains rate, which is the tax rate of the investor's ordinary income. In this example, that rate is 39.6%. Assume the investor's portfolio gains and losses, and trading activity for the year look as follows:


Mutual Fund A: $250,000 unrealized gain, held for 450 days

Mutual Fund B: $130,000 unrealized loss, held for 635 days

Mutual Fund C: $100,000 unrealized loss, held for 125 days

Trading Activity:

Mutual Fund E: Sold, realized a gain of $200,000. Fund was held for 380 days

Mutual Fund F: Sold, realized a gain of $150,000. Fund was held for 150 days

Without tax-loss harvesting, the tax liability from this activity is:

Tax without harvesting = ($200,000 x 20%) + ($150,000 x 39.6%) = $40,000 + $59,400 = $99,400

If the investor harvested losses by selling Mutual Funds B and C, they would help to offset the gains, and the tax liability would be:

Tax with harvesting = (($200,000 - $130,000) x 20%) + (($150,000 - $100,000) x 39.6%) = $14,000 + $19,800 = $33,800

The proceeds of the sales can then be used to invest in assets similar to the ones sold.

  1. Capital Gains Tax

    A capital gains tax is a type of tax levied on capital gains ...
  2. Capital Gain

    Capital gain is an increase in a capital asset's value that is ...
  3. Capital Gains Distribution

    The payment of proceeds prompted by a fund manager's liquidation ...
  4. Unrealized Loss

    If the value of a transaction that has yet to be completed falls ...
  5. Capital Gains Treatment

    The amount of time a stock is owned before being sold determines ...
  6. Unrealized Gain

    A profit that exists on paper, resulting from any type of investment. ...
Related Articles
  1. Taxes

    'Tis The Season For Tax-Loss Harvesting

    With the end of the year upon investors are looking for ways to reduce their tax bill. One tactic that is often used is tax-loss harvesting.
  2. Tech

    Using Tax-Loss Harvesting to Keep Your Gains

    Harvesting tax losses is a key skill that investors can use to keep more of their money in their pockets the next time they file taxes.
  3. Taxes

    Tax-Loss Harvesting: Reduce Investment Losses

    The option to bolster after-tax stock returns through tax-loss harvesting can reverse investor gloom.
  4. Investing

    7 Year-End Tax Planning Strategies

    Do you have a capital loss that could be booked and used to offset future tax liabilities? If so, it may be time to sell.
  5. Financial Advisor

    How to Dodge Big Tax Hits on Your Portfolio

    An investment plan that helps clients minimize related tax hits adds even more value to an already well-thought out strategy. Here are some tips.
  6. Taxes

    7 Ways to Create a Tax-Efficient Portfolio

    Taxes may be a necessary evil, but that doesn't mean they can't be reduced. Here's a host of smart moves today's investors can make.
  7. Taxes

    Year-End Tax Planning That Will Boost Your Returns

    Year-end tax planning is crucial to take advantage of strategies to maximize after-tax returns on your investments.
  8. Taxes

    Capital Losses and Tax

    Capital losses are never fun to incur, but they can reduce your taxable income. Knowing the rules for capital losses can help you maximize your deductions and make better choices about when to ...
  9. Taxes

    3 Tax Implications of Dividend Stocks

    Dividend paying companies are attractive in a low interest rate environment, but income seeking investors have to be careful of the potential tax hit.
  10. Investing

    7 Tips for Tax-Managed Investing

    Use these seven tips to reduce the tax impact on your taxable portfolio.
Hot Definitions
  1. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  2. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  3. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  4. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  5. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  6. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
Trading Center