Quick summary:
Tax-loss harvesting is a technique where you sell investments that have fallen in value to realize a loss. That loss can offset capital gains (and sometimes ordinary income), lowering the taxes you pay now or in future years. It’s not magic, but done right it keeps more money invested and compounding. Vanguard
What is tax-loss harvesting?
Tax-loss harvesting (TLH) means selling a holding that has dropped below your purchase price so you realize a capital loss. You then typically replace it with a similar — but not “identical” — investment so you stay invested while capturing the tax loss. Many robo-advisors and advisors automate this for taxable accounts. Vanguard+1
How Tax-Loss Harvesting actually saves you money — the mechanics
- Offset capital gains: Realized losses first offset realized capital gains in the same tax year. That reduces taxable gains dollar-for-dollar. Vanguard
- Reduce ordinary income (U.S. only, limited): If losses exceed gains in the U.S., you can deduct up to $3,000 ($1,500 married filing separately) against ordinary income each year; excess losses carry forward. IRS+1
- Canada: Net capital losses can be carried back 3 years or forward indefinitely to offset taxable capital gains in other years. Also remember the capital gains inclusion rate (50% for recent years) — that affects the taxable impact of a loss. Government of Canada+1
Simple example — Canada (showing digit-by-digit math):
- Realized capital loss = $10,000.
- Inclusion rate = 50% → taxable effect = $10,000 × 0.50 = $5,000.
- If your marginal tax rate = 30% → tax saved = $5,000 × 0.30 = $1,500. Government of Canada
Simple example — U.S. (digit-by-digit math):
- Realized capital loss = $10,000 that offsets $10,000 of gains taxed at your ordinary rate (say 24%).
- Tax saved = $10,000 × 0.24 = $2,400. IRS
(Examples are for illustration. Your actual savings change with your tax bracket, type of gain, and local rules.)
Key rules & traps to avoid
- Wash sale (U.S.) / Superficial loss (Canada): You cannot claim a loss if you (or an affiliated person) buy the same or identical security within 30 days before or after the sale. This disallows the loss (or defers it to the new position’s cost base). Avoid repurchasing identical securities inside the window.
- Don’t TLH in tax-advantaged accounts: Selling in an RRSP/TFSA (Canada) or an IRA/401(k) (U.S.) doesn’t create a deductible loss — TLH applies to taxable accounts only. Vanguard
- Transaction costs & tracking: Commissions, bid-ask spreads, and administrative complexity can reduce the benefit. Automated services often weigh these costs before harvesting.
- Short-term vs long-term losses: In the U.S., short-term and long-term losses offset the corresponding gains first; the tax impact differs by holding period. Check Schedule D / Form 8949 rules when reporting.
Practical Tax-Loss Harvesting playbook — step-by-step
- Review taxable accounts for positions below cost.
- Identify candidates where selling won’t disrupt your target asset allocation.
- Check timing: ensure you won’t trigger a wash/superficial loss (30-day window). Government of Canada+1
- Choose replacements: buy a similar but not identical ETF or fund (e.g., swap an S&P 500 ETF from one issuer for another or use a total market fund with similar exposure).
- Document everything: trade confirmations, dates, proceeds, cost basis — you’ll need these for tax forms (e.g., Form 8949 + Schedule D in the U.S.; T4037 and T1 reporting in Canada). IRS+1
- Repeat when wise: harvest losses throughout the year (many advisors focus on year-end reviews). Automation helps. Wealthfront+1
Who benefits most from Tax-Loss Harvesting?
- Taxable investors with non-registered accounts.
- High-income investors in higher tax brackets.
- Portfolios that frequently realize gains (e.g., rebalancing or active trades).
- Investors who hold diversified index ETFs — replacements are easy to find to avoid wash/superficial rules. Vanguard+1
Tools & services that automate Tax-Loss Harvesting
Many robo-advisors and wealth managers offer automated TLH (some only for accounts above a minimum). Examples: Wealthfront, Vanguard’s managed services, and several large advisors provide TLH as a feature. Automation reduces tracking errors and can harvest more opportunities than manual checks. Wealthfront+1
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FAQs
Q: Will tax-loss harvesting save me money every year?
A: Not necessarily every year. TLH can reduce taxes now and defer taxes later. Its value depends on gains, losses, your tax bracket, and costs (trades, tracking). Automation helps identify consistent opportunities. Vanguard+1
Q: Can I harvest losses inside my TFSA / RRSP / IRA?
A: No. Losses in tax-advantaged accounts don’t create deductible tax losses. TLH is useful in taxable accounts only. Vanguard
Q: How long is the wash/superficial window?
A: In both jurisdictions the rule centers on a 61-day span (30 days before + the sale day + 30 days after). In Canada it’s called the superficial loss rule; in the U.S. it’s commonly the wash sale rule. Avoid repurchasing identical securities in that window. Government of Canada+1
Bottom line
Tax-loss harvesting is a practical tool to lower taxes and improve after-tax returns when used correctly. The biggest wins come from careful planning, avoiding wash/superficial rules, and using automation or professional advice if your portfolio or tax situation is complex.
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