Yes, You Can Still Find Tax-Loss Harvesting Opportunities in 2024

Margaret Giles: Welcome to Investing Insights. I’m your host, Margaret Giles. The US market has been red-hot, so there’s a good chance that your investment portfolio has made some significant gains this year, but you might have to brace for a hefty tax bill if you hold those investments in a taxable account. Tax-loss selling might help you lower that tax bill, but you have to do it right.

Christine Benz is director of personal finance and retirement planning for Morningstar. We talk about how tax-loss selling works and who it works for, as well as where investors might find loss opportunities in their portfolios. Here’s our conversation.

Well, thanks for being here today, Christine. I really appreciate it.

Christine Benz: Margaret, it’s great to see you.

What Is Tax-Loss Selling?

Giles: All right, so I want to talk about tax-loss selling. It’s relevant for this time of year. Let’s start with the basics. What is tax-loss selling and who should really be thinking about it?

Benz: Tax-loss selling means that you’re going to take a look into your portfolio and look for securities that are now selling at a price below what you purchased them at, or your cost basis. In terms of who should be looking at tax-loss selling, well, it is an activity that will be almost exclusively focused on your taxable accounts. So, if you have tax-sheltered accounts, technically you could do tax-loss selling, but you’d have to liquidate your whole IRA in order to engage in tax-loss selling. So, not recommended for most people.

This is generally if you have taxable brokerage accounts, the idea is that you are looking into your account to see if you have losses in that portfolio. And the reason to consider it, especially in a year like this year where a lot of people have gains in their portfolio, is that you can use those losses to offset capital gains and in turn the tax impact of those capital gains.

Giles: Got it. So, it’s really just taxable accounts.

Benz: Yes.

Giles: Let’s keep it there and get away from the tax-sheltered accounts.

Benz: Yes, definitely.

Are There Limits to How Much You Can Offset Capital Gains?

Giles: Is there a limit to how much you can offset and how does that work?

Benz: In terms of the capital losses that you can take to offset capital gains, that’s unlimited and you can also carry them forward into future years. Say if in 2024 you have a lot of taxable losses for some strange reason and you do not have offsetting capital gains, well, those losses can be carried forward in perpetuity.

The limit comes in if you have exhausted your capital gains, so your capital losses have sopped up all of your capital gains and you still have leftovers, you can use them to offset up to $3,000 in ordinary income. That $3,000 threshold has not changed for a couple of decades now, but it is something that you can do if your losses more than offset your gains.

Knowing Your Cost Basis Is Key to Finding Tax-Loss Harvesting Opportunities

Giles: Good to know. So you mentioned your cost basis, how much you paid for your investments, and that’s key to finding those loss opportunities. But there are a couple of different ways to calculate or consider your cost basis and maybe there are a couple of things to consider as you’re looking at that. What are those different methods and what should people think about?

Benz: I don’t think there’s enough attention paid to this, Margaret. There are different methods of electing to track cost basis, and very often people are just defaulted into whatever their investment firm or brokerage firm is using. So, it’s very common for people with individual stock portfolios. They use what’s called the first-in, first-out method. So, the securities that you bought first are assumed to be the ones that you’re selling.

If you don’t sell that whole position, they’re going to assume that you are selling those first-purchased securities first. And that’ll tend to be pretty tax-unfriendly if the market usually goes up and they’re selling the ones that you purchased first. So, it’s often wise to override that and use what’s called specific share identification. That actually gives you the ability to cherry-pick where you go if you’re doing tax-loss selling and lets you cherry-pick individual lots that are most advantageous for you to sell at any given point in time.

That’s particularly valuable for stock investors where you’re probably purchasing at different intervals, you may be selling at different intervals. It just gives you the highest level of control. If you’re a mutual fund investor, the typical default cost basis is what’s called the averaging method, where they’re averaging all your different purchase prices together. It’s never going to be the best method because it is an average.

It’s the simplest, and it’s what many fund investors go with. And it’s important to note, Margaret, for people who use the averaging method and they’ve sold things from that mutual fund portfolio, you have to stick with that cost-basis method. You can’t change it around. So, people need to know what type of cost-basis election they have selected and use that to inform the choices that they’re able to make in terms of tax-loss selling.

What Is the Wash-Sale Rule for Tax-Loss Selling?

Giles: Got it. That’s really helpful. I think that sounds like one of the ways that this strategy could go awry if you think your cost basis is one thing, but it’s actually another because you’ve fallen into those defaults. Certainly good to think about. How else can tax-loss selling go awry? One thing that comes to mind is the IRS wash-sale rule. Can you talk about what that is?

Benz: So, the idea with tax-loss selling, if you take a tax loss and you want to try to use that to offset gains or maybe even ordinary income as we were talking about, the issue is that you can’t go out and buy what the IRS calls a substantially identical security within 30 days of having sold that security and booked a loss. A good example here would be, I have a total market fund and I want to sell it. Of course, a total market fund would be way up this year.

But if it’s 2022 again, for example, and a total market fund is down and I want to try to sell it, I can’t sell the traditional mutual fund and swap into the ETF within 30 days of having made that sale. So, that’s substantially identical. The same would go if I’m a stock investor and I sell out of a stock and I want to buy another share class of that same stock. Cannot do that either.

But there’s a lot of flexibility in the realm of, oh, I want to sell this actively managed fund that I don’t like, say a large-growth fund, and buy a large-growth ETF. Perfectly fine. Same with I want to sell X individual stock and buy another stock in the same sector. A-OK. Or buy maybe an ETF tracking that sector. That’s totally fine too. You have quite a lot of leeway, but I would just be careful about monkeying around with securities that are pretty alike in terms of the economic exposure that they offer you.

Why Investors Should Consider Tax-Loss Selling Even When Markets Are Up

Giles: Got it. So, at least there’s that flexibility where you can essentially have a fund, for example, that fits a role in your portfolio, but you’re able to tweak the active versus passive, for example. And so you’re still filling that role, but the IRS isn’t treating that as, what is it, substantially identical.

Benz: Exactly, exactly. And it’s important to remember that oftentimes the securities that you might have the losses in, they may be cheap, that they may be industries or areas where you would want to maintain economic exposure. There may be a real portfolio fundamental case to maintain exposure to that same area, just do it in a different way.

Giles: Absolutely. You’ve already alluded to this a little bit, the markets are up this year. Why should investors think about tax-loss selling right now?

Benz: Well, because the markets have been up, many investors do have gains in their portfolios that they might like to realize, and that entails a tax bill unless you have offsetting losses. And another thing that we have going on right now, we have this in the fourth quarter of every year, we have mutual funds making these capital gains distributions. Taking tax losses elsewhere in your portfolio is a way to offset those gains and in turn the tax bills associated with them.

So, it’s worth looking around. From a practical standpoint, if I’m someone who has a plain-vanilla portfolio of broad market mutual funds, whether I’m going to be able to turn up a lot of tax-loss sale candidates is an open question. But there are a couple of areas where I would urge people to take a look.

One would be if people had been buying fixed-income investments within the past couple of years and they had been leaning into long-term bonds, that was a really popular trade coming into 2023 because we thought interest rates were going to drop really rapidly. Didn’t really happen that way, so many investors do have losses in their portfolios in the long-term bonds, especially long-term government bonds. So, you may be able to lighten up on those positions and take losses there. Perhaps get into a portfolio that’s more in the intermediate to short-term zone. That’s one area to consider.

If you look at emerging markets, we’ve seen some losses in certain markets. China, in particular, has been under a cloud, and so people who have China-specific exposure may have losses in their portfolio. Latin America very recently has had losses. And then I would also say, Margaret, for individual stock investors, I think there are much better opportunities even for US stock investors.

The US market has been great, but I was looking last night: 1,100 companies—global companies, so US, non-US—with market caps of more than a billion have losses of more than 10% over the past year. And a similar number of like-sized companies have 10% or greater losses over the three-year period. So, if you are an individual stock investor, you do have a greater likelihood of being able to unearth some losses, and then you can do some repositioning elsewhere in your portfolio.

Giles: I appreciate the reminder that we should look a little longer term. I think it’s tempting to say, “Ah, the market’s been up this year. There’s no opportunities to be found.” But if you take that longer-term view, there are potentially some opportunities.

Benz: Definitely. If investors have been on autopilot with their portfolios, which by the way is a great way to invest, they may find that they have some losses. And I would say that the fixed-income piece is a little bit unusual. We don’t typically see losses in fixed-income funds. It’s been a bad run for long-term fixed income. So, that’s a particularly rich vein. Even for investors who weren’t trying to get cute with their portfolios, they may find the opportunity to unlock some losses there. So, I would take a look.

How to Make Tax-Loss Selling a Part of Your Portfolio Maintenance Strategy

Giles: In your view, is there a right way to go about tax-loss selling? You mentioned taking the strategy in hand with tailoring your portfolio, adjusting, and rebalancing at the end of the year. What do you think?

Benz: I like the idea of locking it into your portfolio maintenance strategy, and I’m pretty hands-off with respect to how much portfolio maintenance investors should do. For me, whether you’re retired or still working and contributing, I think a good once-annual review is plenty for most of us, where we’re tying some of these activities together, where we are looking for rebalancing, potentially looking for tax-loss sale candidates.

For retirees, who are subject to required minimum distributions, you’re getting them into the act as well, as well as potentially some charitable giving. And I think it can be just a cohesive activity. Less is more with respect to portfolio maintenance, but this is a good time of year to do it.

Why Tax-Loss Selling Is Often a Bear-Market Strategy

Giles: So, I want to wrap up. Do you have any final thoughts as people are heading into the end of the year considering tax-loss selling, considering this portfolio maintenance?

Benz: Generally speaking, this is a great bear-market strategy. So, in a 2022-type environment where almost everything was down—stocks, bonds, you name it—this is really a great time to find a silver lining in a difficult market. In markets like this, I think it’ll be a little bit less fruitful in terms of the benefits of tax-loss selling. But look alive. I would say we will have other bear markets, and that tends to be the particularly valuable time to consider tax-loss selling.

Giles: All right. Well, thank you so much, Christine. This has been a good conversation. Thanks for coming to the table.

Benz: Thank you so much, Margaret.

Giles: That wraps up this week’s episode. We’re taking a break next week, so we’ll see you in December. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to senior video producer Jake VanKersen and associate multimedia editor Jessica Bebel. And thank you for watching Investing Insights. I’m Margaret Giles, content development editor at Morningstar.