Using Investment Losses to Potentially Improve Long-Term After-Tax Returns
No investor enjoys seeing an investment decline in value.
However, market downturns sometimes create planning opportunities that aren’t available during strong markets.
One of those opportunities is tax-loss harvesting.
Rather than viewing an investment loss as entirely negative, tax-loss harvesting allows investors to use certain realized losses to potentially reduce current or future taxes.
While it doesn’t eliminate investment losses, it may improve your after-tax investment results over time.
Like many tax strategies, success comes from thoughtful planning rather than reacting emotionally during periods of market volatility.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is the process of selling investments that have declined in value to realize a capital loss for tax purposes.
Those losses may then be used to:
- Offset capital gains realized during the same tax year.
- Offset up to $3,000 of ordinary income annually (subject to IRS rules).
- Carry forward unused losses into future tax years.
This allows investors to potentially reduce their tax liability while repositioning their portfolios.
A Simple Example
Suppose you sell Stock A for a $20,000 gain.
Later in the year, another investment has declined by $12,000.
Selling the second investment realizes a $12,000 capital loss.
Instead of paying taxes on the full $20,000 gain, you may only owe taxes on the net $8,000 gain, depending on your overall tax situation.
Tax-Loss Harvesting Doesn’t Mean Staying Out of the Market
One of the biggest misconceptions is that harvesting a tax loss means moving to cash indefinitely.
Not necessarily.
Many investors replace the investment they sold with another investment that provides similar market exposure while complying with IRS wash sale rules.
The objective is to maintain an appropriate investment allocation while recognizing available tax benefits.
Understanding the Wash Sale Rule
The IRS wash sale rule prevents investors from claiming a tax loss if they purchase the same—or a substantially identical—security within 30 days before or after the sale.
For example:
- Sell ABC ETF today.
- Buy the same ABC ETF next week.
The realized loss generally will not qualify for immediate tax recognition.
Understanding this rule is essential before implementing any tax-loss harvesting strategy.
When Tax-Loss Harvesting Makes Sense
Tax-loss harvesting may be appropriate when:
- Markets experience temporary declines.
- You have realized capital gains.
- Portfolio rebalancing is already needed.
- You wish to improve tax efficiency without significantly changing your investment strategy.
Like many planning strategies, the value often depends on your individual tax situation.
Common Mistakes
Letting Taxes Drive Investment Decisions
Tax savings should never become the primary reason for owning—or selling—an investment.
Sound investment principles should come first.
Ignoring the Wash Sale Rule
Many investors unknowingly eliminate the tax benefit by purchasing substantially identical investments too soon.
Waiting Until December
Tax-loss harvesting opportunities may occur throughout the year.
Waiting until the final weeks of December may limit your options.
Harvesting Losses Without a Plan
Every sale should fit within your long-term investment strategy.
Tax considerations should complement—not replace—your investment objectives.
Why Tax-Loss Harvesting Matters in Retirement
Many retirees continue investing in taxable brokerage accounts after retirement.
Tax-loss harvesting may help:
- Offset capital gains from portfolio rebalancing.
- Improve after-tax investment returns.
- Reduce taxable income (within IRS limits).
- Create greater flexibility for retirement income planning.
While not appropriate every year, it remains one of the most valuable tax-planning tools available to taxable investors.
Point Wealth Insight
Many investors view market declines as something to avoid at all costs.
While no one welcomes investment losses, temporary declines can sometimes create meaningful planning opportunities.
Tax-loss harvesting is a good example. Rather than reacting emotionally to short-term volatility, disciplined investors may be able to improve long-term after-tax outcomes by recognizing losses strategically while maintaining an appropriate investment allocation.
This is another example of why investment management and tax planning should work together—not independently.
Ask the Advisor
Market volatility can be uncomfortable, but it may also create opportunities.
Before selling investments solely for tax purposes, review your portfolio with your financial advisor to ensure the decision supports your long-term investment strategy as well as your tax planning goals.
Continue Learning
- Capital Gains in Retirement: How to Sell Investments Without Paying More Tax Than Necessary
- The Retirement Tax Gap: Why Your CPA and Financial Advisor Should Work Together
- IRA Withdrawals Before Required Minimum Distributions Begin
Sources
- Internal Revenue Service – Topic No. 409: Capital Gains and Losses.
- Internal Revenue Service – Publication 550: Investment Income and Expenses.
- Internal Revenue Service – Wash Sale Rules.
- U.S. Securities and Exchange Commission – Investor education on taxes and investing.