How Americans Are Using Tax-Loss Harvesting to Offset Investment Gains
Let’s face it – nobody likes paying taxes, especially on their investments. But what if you could legally reduce your tax bill while keeping your investment strategy intact? That’s exactly what tax-loss harvesting lets you do!
Once a strategy primarily used by wealthy investors with financial advisors, tax-loss harvesting is now something everyday investors can use to potentially save on taxes each year.
What Is Tax-Loss Harvesting? (Explained Simply)
Tax-loss harvesting is taking investments that have gone down in value, selling them to create a “loss” on paper, and then using that loss to reduce taxes on your winning investments. It’s like turning lemons into lemonade!
HERE’S A REAL-WORLD EXAMPLE:
Let’s say you bought $10,000 worth of Tech Company XYZ stock last year. Unfortunately, it’s now worth only $7,000 (a $3,000 loss).
Meanwhile, your other investment in Healthcare Company ABC has done great! You bought it for $5,000 and it’s now worth $9,000 (a $4,000 gain).
If you sell both:
- Without tax-loss harvesting: You’d owe taxes on the $4,000 gain
- With tax-loss harvesting: Your $3,000 loss from Tech Company XYZ offsets most of your $4,000 gain from Healthcare Company ABC, so you only pay taxes on $1,000!
The best part? After selling Tech Company XYZ, you can immediately buy a similar (but not identical) tech investment to maintain your market exposure. This keeps your investment strategy intact while capturing the tax benefit!
Why More Americans Are Doing This Than Ever Before
According to a study published in the Journal of Financial Planning, automated tax-loss harvesting programs can identify significantly more loss harvesting opportunities compared to manual methods. Research from Betterment, a leading robo-advisor, shows their tax-loss harvesting service has historically added an average of 0.77% in after-tax returns annually to clients’ portfolios.
This accessibility has contributed to more widespread adoption among average investors, not just the wealthy.
When Market Crashes Become Tax-Saving Opportunities
Here’s something counterintuitive: market downturns can actually be good news for tax purposes!
Research published in the AAII Journal (American Association of Individual Investors) has documented increased tax-loss harvesting activity during significant market corrections. The market volatility in 2020 created substantial tax-loss harvesting opportunities for investors who maintained their long-term investment strategy.
These investors effectively locked in valuable tax losses when prices were low, then maintained market exposure for the recovery that followed.
Apps Are Making This Super Easy Now
You don’t need a fancy financial advisor to do tax-loss harvesting anymore. Robo-advisors like Wealthfront and Betterment now offer automated tax-loss harvesting!
According to Morningstar’s research on robo-advisors, automated tax-loss harvesting can add between 0.6% and 1.1% in additional after-tax returns annually. While this might not sound like much, compounded over decades it can translate to meaningful portfolio growth.
These platforms can identify small opportunities across accounts that might be missed with less frequent portfolio reviews.
Robo-Advisor Tax-Loss Harvesting Performance
| Robo-Advisor | Avg. Annual Tax-Loss Harvesting Return | Minimum Investment | Fees |
|---|---|---|---|
| Betterment | 0.77% | $0 | 0.25% |
| Wealthfront | 0.65% | $500 | 0.25% |
| Schwab Intelligent Portfolios | 0.50% | $5,000 | $0 |
| Fidelity Go | 0.45% | $10 | 0.35% |
The One Rule You Must Follow: No “Wash Sales”
There’s one big rule you need to know about: the IRS “wash-sale rule.” It says you can’t claim a tax loss if you buy back the same investment (or one that’s “substantially identical”) within 30 days before or after selling.
The workaround? Sell one investment and immediately buy something similar but different.
For example:
- SELL: Vanguard S&P 500 ETF (VOO)
- BUY: SPDR S&P 500 ETF (SPY)
Both track the same index, but they’re technically different investments. This keeps you in the market while still capturing the tax loss!
It’s important to be careful with this rule – investors who inadvertently trigger wash sales may find their expected tax benefits disallowed by the IRS.
| Scenario | Tax Outcome | Recommended Action |
|---|---|---|
| Sell at Loss | Potential Tax Deduction | Wait 31 days before repurchasing |
| Sell at Loss & Immediately Repurchase | Tax Loss Disallowed | Buy similar (but not identical) investment |
| Sell Multiple Lots | Individual Lot Analysis | Consult Tax Professional |
| Cross-Account Transactions | Potentially Complicated | Careful Tracking Required |
Demographic Trends in Adoption
Research from financial services firms suggests that younger investors appear to be adopting tax-loss harvesting at higher rates than older generations. This likely reflects both technological comfort and investment philosophy differences.
Younger investors who have witnessed multiple market cycles in their investing lifetimes may be more willing to actively manage their portfolios for tax efficiency rather than adopting a pure buy-and-hold approach.
It’s Not Just for Stocks Anymore
| Asset Class | Potential Tax-Loss Harvesting Opportunity | Typical Market Volatility |
|---|---|---|
| Stocks | High | Very High |
| Bonds | Moderate | Low to Moderate |
| REITs | Moderate | Moderate |
| Commodity ETFs | Moderate | High |
| International Equity Funds | High | High |
While most people think of tax-loss harvesting for stocks, research published in the Journal of Wealth Management shows the strategy can be effective across multiple asset classes:
- Fixed-income investments (bonds)
- Real estate investment trusts (REITs)
- Commodity ETFs
- International equity funds
This diversification allows for more tax-loss harvesting opportunities throughout market cycles.
The Psychological Benefit
Research in behavioral finance has documented how systematic tax management can positively impact investor behavior. Investors who view market declines as potential tax-saving opportunities may be less likely to make emotional selling decisions during market corrections.
This “loss reframing” can help investors maintain discipline during volatile markets by focusing on the potential silver lining of tax efficiency.
Direct Indexing: The Future of Tax-Loss Harvesting
The cutting edge of tax-loss harvesting is something called “direct indexing.” Instead of buying an ETF or mutual fund, you own all the individual stocks in an index.
This lets you harvest losses on individual stocks while keeping your overall market exposure. For example, if most of the S&P 500 is up but 100 companies are down, you can harvest losses on just those 100 companies.
According to research from Cerulli Associates, assets in direct indexing strategies have been growing significantly as technology has made this approach more accessible to investors beyond the ultra-wealthy.
Who Benefits Most From Tax-Loss Harvesting?
The higher your income and tax bracket, the more you’ll likely benefit from tax-loss harvesting. IRS Statistics of Income data shows higher percentages of tax filers in upper income brackets report capital losses compared to lower income brackets.
This makes sense because:
- Higher-income investors typically have more investment assets
- Pay higher marginal tax rates, making each dollar of tax savings more valuable
- Are more likely to have access to sophisticated financial advice
However, the strategy can still provide benefits for investors across income levels who have taxable investment accounts.
The Limitations You Should Know About
Tax-loss harvesting isn’t perfect. Academic research points out that:
- It mainly defers taxes rather than eliminating them completely
- It doesn’t help with investments in retirement accounts like IRAs and 401(k)s
- The benefits are reduced if you plan to sell everything within a short time horizon
- It adds some complexity to your tax situation
The Bottom Line: A Strategy Worth Knowing
Tax-loss harvesting has become more mainstream because research suggests it can be effective at reducing tax burden while maintaining investment strategies. Americans across different wealth levels are increasingly using it to potentially improve after-tax returns.
The strategy gives investors more control over their tax situation. When markets inevitably experience downturns, tax-loss harvesting provides a method to potentially benefit from temporary losses.
With more tools making this accessible to everyday investors, tax-loss harvesting has become a more common strategy for investors who want to keep more of their investment returns.
Want to Get Started? Here’s Your Action Plan:
- Check your investment accounts for any positions currently at a loss
- Identify potential replacement investments that are similar but not identical
- Consider automated solutions like robo-advisors if you want the process handled for you
- Consult with a tax professional if you’re unsure about your specific situation
- Remember that even small harvested losses can add up to significant tax savings over time
Remember: The market will always have ups and downs. Tax-loss harvesting lets you make those downs work in your favor!
