Tax-loss harvesting is a strategy used to reduce taxable capital gains of your portfolio: You deliberately sell assets that have incurred losses to offset current or future capital gains.
Example: Assume a single investor earns an income of $580,000 in 2023. The investor's marginal income tax rate is 37% and is subject to the highest long-term capital gains tax category, where gains are taxed at 20%. Short-term capital gains are taxed at the investor's marginal rate.
Below are the investor's portfolio gains and losses and trading activity for the year:
Portfolio:
Stock A: $250,000 unrealized gain, held for 450 days
Stock B: $130,000 unrealized loss, held for 635 days
Stock C: $100,000 unrealized loss, held for 125 days
Trading Activity:
Stock E: Sold, realized a gain of $200,000. It was held for 380 days
Stock F: Sold, realized a gain of $150,000. It was held for 150 days
The tax owed from these sales is:
Tax without harvesting = ($200,000 x 20%) + ($150,000 x 37%) = $40,000 + $55,500 = $95,500
If the investor harvested losses by selling stocks B and C, the sales would help to offset the gains, and the tax owed would be:
Tax with harvesting = (($200,000 - $130,000) x 20%) + (($150,000 - $100,000) x 37%) = $14,000 + $18,500 = $32,500