13 Methods to Screw Up Tax-Loss Harvesting

By Dr. Jim Dahle, WCI Founder

Tax-loss harvesting is the method of claiming losses to make use of in your taxes with out truly altering your portfolio in any important manner.

For instance, a typical tax-loss harvesting transfer for me can be to attend till the market drops; then I would take the final one or two or three tax plenty of VTI (the Vanguard Whole Inventory Market Index Fund ETF) that I’ve bought and promote them. Thirty seconds later, I exploit the cash from these gross sales to buy a single lot of ITOT (the iShares Whole Inventory Market Index Fund ETF). My portfolio actually hasn’t modified in any important manner, however I’ll have booked a $1,000, $10,000, and even $100,000 loss that I can use on my taxes. A limiteless quantity of these losses can be utilized in opposition to capital beneficial properties and as much as $3,000 per 12 months can be utilized in opposition to extraordinary earnings, with all unused losses being carried ahead indefinitely.

I do not discover this course of to be notably difficult. However I even have 20 years of expertise placing in purchase and promote orders—and about that a lot time educating others how to do that course of. Just like the Backdoor Roth IRA course of, I’m regularly amazed at the entire other ways individuals can screw up tax-loss harvesting. Let me define just a few of them right now within the hopes that it’ll assist others keep away from them.

#1 Making an attempt to Tax-Loss Harvest in a Retirement Account

You solely pay capital beneficial properties taxes on beneficial properties in your taxable non-qualified brokerage account. You do not pay them on beneficial properties in tax-protected accounts like 401(okay)s, Roth IRAs, HSAs, and 529s. Since capital beneficial properties taxes do not apply to these accounts, capital losses inside these accounts do not depend for something. So, do not trouble making an attempt to tax-loss harvest in these accounts.

#2 Working Afoul of Wash Sale Guidelines

You may’t promote shares of a inventory or mutual fund, guide the loss, after which purchase again shares of the very same inventory or fund instantly. That is known as a wash sale, and the loss is disallowed. You may’t purchase that funding for 30 days afterward. You can also’t purchase it throughout the 30 days simply earlier than, except you additionally promote that specific tax lot of shares.

You may’t purchase shares on February 15, purchase shares once more on March 15, after which simply promote the primary tax lot on March 20 and hope to say a loss. That is a wash sale. No loss for you. It’s a must to promote the February 15 lot AND the March 15 lot. No drawback with that. You in all probability wish to anyway, so this is not often an enormous deal so long as you perceive the rule. By the way, wash sale guidelines do not apply to cryptoassets, so promote your Bitcoin and purchase it again instantly each time it drops in worth.

Extra data right here:

Is Tax-Loss Harvesting Value It?

Tax-Loss Harvesting Pairs and Companions

#3 Worrying Too A lot About Wash Sale Guidelines

When individuals first study in regards to the wash sale guidelines, the following factor they often do is get all nuts about them. For instance, one of many guidelines is which you can’t promote shares in your taxable account after which simply purchase those self same shares in your IRA and declare the loss. Looks like an affordable rule, proper? Guess what? It does not apply to 401(okay)s. You may promote the shares in your taxable account and purchase these very same shares 10 seconds later in your 401(okay). No wash sale. Possibly it breaks the spirit of the wash sale rule, however it actually does not break the letter of the legislation.

One other frequent one is that folks begin going bonkers making an attempt to interpret what the IRS means when it says you may’t purchase one other safety that’s “considerably an identical” and declare the loss. So long as it’s a totally different inventory or a special fund, it is wonderful. You may’t trade two share lessons of the identical fund (promote the mutual fund and purchase the ETF model of a fund, as an illustration), however nearly all the things else goes.

This one once more could appear to interrupt the spirit of the legislation (for instance, swapping one whole inventory market fund for an additional, as in my instance above), however after a decade-plus of difficult anybody to point out me a case the place the IRS had an issue with it, I nonetheless do not know anyone who is aware of anyone who was audited on this level and had a loss disallowed. The argument for swapping one whole inventory market fund for an additional is likely to be a little bit weak, however they’re separate funds run by separate corporations that personal totally different shares as they pattern the index. If it actually bothers you, swap a complete inventory index fund for a 500 index fund. Their correlation continues to be 0.99, however one has 500 shares and the opposite has 4,000. Fairly arduous to argue these are “considerably an identical.”

#4 Turning Certified Dividends into Non-Certified Dividends

Most inventory dividends and, thus, most inventory mutual fund dividends are “certified dividends.” They’re certified with the IRS for a decrease tax price than “extraordinary dividends.” Nonetheless, certified dividend tax remedy is not for day merchants. It’s a must to personal the inventory for 60 days throughout the 121 days across the ex-dividend date to get that particular tax remedy.

For those who purchased shares on March 15, obtained a dividend on March 25, and tax-loss harvested the shares on April 20, that March 25 dividend goes to be taxed on the larger extraordinary earnings tax charges. If the dividend was $1,000 and also you’re in the highest tax brackets, that would imply paying $408 in tax as a substitute of $238 on that dividend. That tax loss had higher be price greater than $160 in tax profit. Even worse, if you happen to had simply waited just a few extra weeks to tax-loss harvest, you would have in all probability had the complete loss AND the certified dividend remedy. Solely in a really brief downturn (just like the March 2020 Coronabear) do you’ve lower than 60 days to do your tax-loss harvesting. In most bear markets, you actually have months to get it finished.

#5 Exchanging from One Mutual Fund Household to One other at Constancy

Most individuals investing in inventory mutual funds in a taxable account ought to be utilizing ETFs as a substitute of conventional mutual funds. You do not have to, although. For those who use conventional mutual funds, you simply trade the 2 funds at 4pm ET as a substitute of promoting one after which shopping for one other through the day. That often works wonderful. So, think about my shock once I acquired this e mail from a Constancy investor:

“I needed to reap the benefits of the markets being down and did some tax-loss harvesting in my brokerage account at Constancy. I noticed the choice when going by way of the method to do an ‘trade’ versus simply promoting the fund that I needed to tax-loss harvest after which individually shopping for the fund I needed to trade it with. I mistakenly thought this could result in the commerce going by way of on the identical day to keep away from the every day fluctuations out there. After I did the trade on this manner, the sale went by way of on April 8 (markets at their lowest just lately) and the purchase went by way of on April 9 (the day the markets began to rebound). So, it looks like I truly misplaced cash on this trade. I believe I simply acquired terribly unfortunate with promoting the day earlier than after which shopping for again on the day the market rebounded.

• April 7 — Change commerce entered into Constancy (PRWAX trade for FXAIX)
• April 8 — Sale of PRWAX went by way of.
• April 9 — Sale of PRWAX settled. Buy of FXAIX went by way of.”

I could not consider it. How may Constancy presumably suppose this was OK? I’ve used “trade” at Vanguard up to now (though admittedly all the time with two Vanguard funds), they usually actually did “trade”—one being bought at 4 PM and the opposite being purchased at 4 PM on the identical day. I advised this WCIer proceed to push this with Constancy, as I believe the brokerage ought to make up her loss to her, particularly since there was no warning given to her that these two trades would happen on separate dates. I am going to let you understand if she succeeds.

Within the meantime, do not trade between two totally different fund households, not less than at Constancy.

Extra data right here:

Easy methods to Tax-Loss Harvest with Vanguard

Tax-Loss Harvesting with Constancy

#6 Not Exchanging Funds at Vanguard

One other WCIer emailed me with nearly the alternative drawback at Vanguard.

“I seemed once more and I used to be as much as like $45,000 in losses. I made a decision to attempt tax-loss harvesting once more, intending to simply do it over the telephone with Vanguard. After sitting on maintain for some time, after which with clinic sufferers beginning to arrive, I ditched the customer support rep and determined to do it on-line. I noticed a weblog submit saying to simply promote one fund and purchase the opposite, NOT to make use of the “trade” tab on the web site. Honest sufficient. So I bought VTSAX for round $180,000 and VTIAX for round $45,000; all heaps have been pink since I began contributing a couple of 12 months in the past. I purchased an equal quantity of an S&P 500 index, however then was brief about $10,000 to purchase a special worldwide index. I checked out why and realized it hadn’t credited me any money for the gross sales I had simply made; it was forcing me to make use of cash market once more, and I didn’t have fairly sufficient to cowl. So I left the $45,000 alone, in an effort to be cleaner and preserve it to solely a single transaction. [I] got here again to it early this morning and purchased the totally different worldwide fund with the money that had settled since yesterday. Effectively, because it was a mutual fund, the commerce didn’t undergo till shut of enterprise right now, and also you noticed what occurred to the markets in the midst of the buying and selling session when Trump introduced a 90-day pause on tariffs. Fortunately the worldwide funds *solely* went up 5.85% vs. 9.52% for home, however what a catastrophe! I primarily misplaced $2,500 making an attempt to tax-lost harvest to cut back my 2025 marginal tax burden by solely $1,000.”

I am undecided why Vanguard did not use the cash from the sale for the acquisition. I would be on the telephone with Vanguard to attempt to kind this out and see if it will make me complete if I could not get it sorted out prematurely. That may be fairly powerful when doing this between sufferers, although.

#7 Placing in Mutual Fund Orders Too Early within the Day

These final two examples exhibit among the explanation why I usually desire ETFs to conventional funds in taxable accounts. There are additionally extra and higher tax-loss harvesting companions. ETFs, not less than when there aren’t each conventional and ETF share lessons for that fund, are a bit extra tax-efficient as a result of their capability to shed capital beneficial properties by way of the share destruction course of with the licensed participant.

Nonetheless, there’s one more benefit of ETFs when tax-loss harvesting. Think about you place in an trade order at 11am ET on April 9, 2025. Then, President Trump introduced a 90-day pause on tariffs, and the market went up 10% earlier than 4pm, when your trade order befell. As an alternative of realizing a capital loss, you notice a capital achieve!

The way in which to keep away from this, if you happen to nonetheless wish to use conventional funds in your taxable account, is to attend till 3:50pm or so to place in that trade order. Whereas it’s usually inadvisable to place in ETF or inventory purchase/promote orders through the first couple of minutes or previous couple of minutes of a buying and selling session as a result of elevated volatility, it is in all probability sensible when tax-loss harvesting conventional funds with an trade order to attend till the previous few minutes of the day.

#8 Wading into Unstable Markets

Unstable markets are usually not an excellent place to play. More often than not once you’re shopping for and promoting shares, you do not need or want volatility, and it is best to keep away from it every time doable. Nonetheless, the very best tax-loss harvesting alternatives often are throughout critical market volatility. That is a dangerous time to be buying and selling, so be additional cautious. Or simply wait till issues are rather less unstable, even when it means you do not get each final loss that you would in any other case seize.

#9 Not Having a Plan and Being Gradual

Even when buying and selling ETFs, you do not wish to let a lot time go between your promote order and your purchase order, particularly in a unstable market. I am often aiming to finish the second order inside one minute of the completion of the primary one. I promote the shares. Then, I verify the order standing to verify it executed. Then, I instantly put within the purchase order. Then, I verify the order standing to verify it executed.

I exploit market orders, and I solely use very liquid ETFs, so these trades, even six-figure trades, usually occur almost instantaneously. To try this, you want to be comfy placing in purchase and promote orders lengthy earlier than you wade right into a unstable market to attempt to seize some tax losses. It is in all probability greatest if you happen to truly write down your plan prematurely and preserve a number of browser tabs open with all the data you would presumably have to execute the commerce. It’s worthwhile to be correct, however you additionally wish to be environment friendly. You do not wish to promote $100,000 price of shares after which solely purchase $10,000 price of shares or put within the incorrect ETF ticker or by chance put in two promote orders as a substitute of 1 promote and one purchase order or promote the incorrect tax lot or anything.

Plan your work, and work your plan. There isn’t a rush to place within the promote order, solely the next purchase order. For those who’re too gradual, it is doable the market worth may rise in between your promote order and your purchase order, and the trade may value you extra from being out of the market than you are gaining in tax profit. However that may not be almost as unhealthy as placing within the incorrect purchase order within the first place.

Extra data right here:

10 Issues to Know When Tax-Loss Harvesting a Giant Taxable Account

#10 Worrying About Shopping for with Unsettled Funds

I often do not have sufficient settled money in my account to cowl the acquisition with out utilizing the “unsettled money” from the sale to purchase the brand new shares. This isn’t an issue—not less than not when utilizing ETFs (see #5 and $6 above for some WCIers’ expertise with conventional funds). Nonetheless, the brokerage will often pop up a scary-looking warning telling you that you simply’re shopping for with unsettled money. That is OK. Do not let it preserve you from placing within the purchase order a part of the tax-loss harvest. It will be wonderful. I promise. The money from the promote order will settle in 2-3 days by the point it’s wanted to finalize the purchase order.

#11 Swapping Conventional Funds for ETFs (and Vice Versa)

For those who actually wish to make a large number, change from conventional funds to ETFs or vice versa whereas tax-loss harvesting. If going from a fund to an ETF, you must wait till the following day to finish the swap. The fund sale does not happen till 4pm, and by then, the market is closed. It is too late to purchase the ETF. If the market goes up in a single day, you may actually be kicking your self. For those who’re going from an ETF to a conventional fund, it is not as unhealthy, particularly if you happen to wait till a couple of minutes earlier than 4pm to place within the orders. The market can nonetheless rise on you, however it’s unlikely to rise too far. It would even fall a little bit bit and provide you with a little bit additional kicker. ETF and mutual fund trades do not all the time decide on the identical day both, which might trigger points.

Do your self a favor. Use one or the opposite, not each, in your taxable account. And ideally ETFs.

#12 Tax-Loss Harvesting Frenetically

Some individuals attempt to eke out each little bit of loss they will. They tax-loss harvest, after which the following day when the market falls once more, they tax-loss harvest once more. Then once more the following day. And once more the next week. And possibly the week after that. They do all of it the way in which down a bear market. However because of the manner the wash sale guidelines work, if you happen to’re doing this extra continuously than each 30 days, you want extra tax-loss harvesting companions for each swap.

By no means tax-loss harvest right into a fund you are not prepared to carry perpetually, in fact. However if you happen to’re utilizing 5 or 6 companions per asset class and have 5 or 6 asset lessons within the taxable portion of your portfolio, it’s possible you’ll ultimately find yourself with 30+ holdings in your taxable account. No person desires that.

It will get even worse if you happen to rent an organization to do that for you, notably you probably have employed somebody to do “direct indexing.” The concept behind it’s in all probability wonderful if the associated fee could be very low (like 10 foundation factors) however solely if you wish to use this service/advisor for the remainder of your life. For those who determine in a 12 months or two that you simply now not wish to pay for this service, it’s possible you’ll discover that you simply now personal dozens of funds and even tons of of particular person shares you may should get rid of your self.

I made a decision just a few years in the past that I solely needed to make use of two tax-loss harvesting companions per asset class so I wasn’t ever going to tax-loss harvest extra continuously than as soon as a month per asset class. And given the 60-day rule for certified dividends, it is not often extra continuously than each couple of months. I believe most who do that for some time will make the identical resolution.

I’ve 4 inventory asset lessons in taxable, and these are my companions:

• US shares: VTI and ITOT
• US small worth shares: AVUV and DFSV
• Worldwide shares: VXUS and IXUS
• Worldwide small worth shares: AVDV and DISV

I occur to have bonds in taxable as nicely and have even tax-loss harvested the muni bond fund a couple of times, though tax-loss harvesting bond funds is rather more uncommon. I exploit VTEAX and VWIUX. As we transfer increasingly more to taxable (our tax-protected accounts are right down to actual property debt, REITs, TIPS, and a little bit US small worth shares), we actually have a TIPS ETF in taxable now (SCHP). We have not needed to tax-loss harvest that but.

#13 Overestimating the Advantages

Tax-loss harvesting is nice. But it surely is not THAT nice. It does not take a lot of a mistake to greater than wipe out all the advantages of tax-loss harvesting. You’ll do nicely to really quantify the advantages you anticipate to see out of your tax-loss harvesting actions. If these advantages are very small, this won’t be price your effort and the chance of a mistake. Deducting $3,000 from my extraordinary earnings every year saves me one thing like $3,000 * (37% + 3.8% + 4.55%) = $1,361 per 12 months in taxes. Beats a kick within the tooth, however it’s not life-changing. And when you hit six figures or so of losses, extra aren’t going to assist at simply $3,000 per 12 months. You will not dwell lengthy sufficient to make use of all of them up, they usually go away at dying.

Nonetheless, these tax losses may also be used to offset capital beneficial properties from the entire following actions:

• Sale of a enterprise or observe
• Sale of an appreciated rental property
• Sale of your residence if beneficial properties are greater than the $250,000/$500,000 exclusion
• Repositioning legacy investments with out tax penalties
• Promoting appreciated shares through the decumulation part (principally only a delay in taxes, however there might be a possible tax price arbitrage)

For those who see any of that in your future, then it might be price fastidiously accumulating extra losses even past $3,000 * your remaining life expectancy.

However do not forget that tax-loss harvesting is non-obligatory. You do not HAVE to do it in any respect to achieve success. Consider it like a Backdoor Roth IRA. Sure, it helps decrease your tax invoice and develop your cash a little bit sooner. But it surely is not going to show somebody who wasn’t going to be financially profitable into somebody who will probably be.

There are greater fish to fry, like insuring adequately, boosting your earnings, rising your financial savings price, implementing an affordable investing plan, and staying the course in a bear market.

What do you suppose? What errors have you ever personally seen or made when tax-loss harvesting? Is tax-loss harvesting nonetheless price it to you?