With Days Left, Here’s How To Tax Loss Harvest In 2023

With only a few trading days left in 2023, tax-loss harvesting can be a useful strategy to improve your after-tax investment results. Researchers have suggested that this strategy can improve yields approximately 1% each year. The paper is "An Empirical Assessment of Tax Loss Harvesting Alpha" by MIT researcher Shomesh Chaudhuri and others analyzing returns from the period 1926 to 2018 for the S&P 500.

This approach may be applicable if you invest in stocks through a U.S. taxable account. Tax-loss harvesting may result in taxable losses, without materially changing portfolio performance. This process can prompt capital gains tax payments in the future. That delay in paying taxes can improve your after-tax investment performance because you can earn a return on that money over a longer period of time instead of paying it to the IRS right away.

How Tax Loss Harvesting Works

If you invest in a taxable account, like a regular brokerage account, you will likely realize capital gains and losses as you buy and sell investments over time. If you only invest in tax-sheltered or tax-deferred accounts, such as 401(k)s, IRAs, and similar vehicles, then you are already deferring or eliminating taxes on your investments and tax-loss harvesting is unlikely to help you.

Tax loss harvesting It focuses on generating taxable losses, especially short-term capital losses, to offset capital gains you would otherwise have to pay.

The way it works is by looking in your account for investments that you've held for less than a year and that are worth less than what you paid for them. These investments may qualify for short-term capital losses. You can then sell these stocks to realize that capital loss, which could then offset capital gains elsewhere in your portfolio.

Wash sales

Importantly, wash sales can disqualify a transaction from suffering a capital loss. Investments you purchased in the last 30 days or repurchased 30 days after the sale may be treated as a wash sale. Wash sales can negate the benefits of tax-loss harvesting as they can avoid a capital loss. Therefore, when tax losses accumulate, if you sell an investment, you must buy something different with the profits. That may mean that if you sell Coca-Cola shares
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Buy Pepsi stock, for example, since buying back Coca-Cola stock within 30 days could trigger a wash sale.

Other warnings

Whether tax-loss harvesting is useful to you also depends on your tax situation. If you're not on track to pay income taxes anyway, then tax-loss harvesting may not bring any benefit. If you don't pay taxes in the first place, offsetting them with capital losses may not help at all.

Additionally, an individual taxpayer can offset as much in capital gains as they wish, but the absolute losses from a tax loss harvesting strategy cannot exceed $3,000 each year for an individual taxpayer.

A summary

Any tax loss carryforwards for your 2023 taxes must be realized before the end of the calendar year. This is different than other tax strategies that have a later deadline. This means there are only a few business days left in 2023 to consider implementing the strategy.

However, of course, the strategy can also be applied in 2024, but it will be applied for tax year 2024. Now may be a good time to look for lost investments that you bought in 2023 and have held for more than 30 days in an account subject to tax. If you sell them and replace them with a similar, but not identical, investment, doing so may offset some capital gains payments in your taxable account.

Alternatively, doing this can create an investment loss of up to $3,000 to offset income tax payments. This process of delaying future capital gains tax payments can improve your overall investment results.