Finding Opportunity in Market Declines: Understanding Tax-Loss Harvesting

This blog does not constitute tax advice. Consult with your tax professional and investment adviser about your specific circumstances.

No one enjoys opening their investment account and seeing red. When markets decline, it’s natural to focus on what your investments have lost. But sometimes, those temporary declines can create opportunities that aren’t immediately obvious.

One example is tax-loss harvesting, a strategy that allows investors to use losses in their portfolios to offset taxable investment gains.

The key is understanding that tax-loss harvesting isn’t about reacting to bad news or trying to predict when the market will recover. It’s about making thoughtful decisions that support your broader financial plan.

And while tax-loss harvesting often gets attention toward the end of the year, it’s a strategy worth considering throughout the year.

 What Is Tax-Loss Harvesting?

Tax-loss harvesting involves selling an investment that has declined in value to realize a capital loss. That loss can then be used to offset capital gains from other investments that have increased in value and been sold.

Consider a simple example:

• You sell Investment A and realize a $10,000 capital gain.
• You sell Investment B and realize a $10,000 capital loss.
• The loss offsets the gain, leaving you with $0 in net taxable capital gains from those two transactions.

Of course, the actual tax treatment depends on your overall investment activity and tax situation.

Capital gains and losses are also treated differently depending on how long you’ve held an investment. Short-term gains, generally from investments held for one year or less, are taxed at ordinary income tax rates. Long-term gains, from investments held for more than one year, generally receive more favorable tax treatment.

Capital losses first offset gains of the same type, with remaining losses then applied against gains of the other type. If your losses exceed your gains, you may be able to deduct up to $3,000 of the remaining net capital loss against ordinary income each year ($1,500 if married filing separately). Additional unused losses can generally be carried forward to future tax years.

This creates an opportunity to think beyond this year’s tax return. A loss realized today may help offset gains in a future year, including a year when your income or investment activity looks very different.

Tax-loss harvesting generally applies to investments held in taxable brokerage accounts, rather than tax-advantaged retirement accounts such as IRAs or 401(k)s.

The Value of Knowing What You Own

A portfolio’s overall performance doesn’t always tell the full story. Even when your investments have performed well over time, individual holdings may have declined in value. Looking beneath the surface can reveal opportunities that might otherwise go unnoticed.

This is one reason ongoing portfolio reviews matter. Understanding what you own, why you own it, and how each investment fits into your financial plan helps inform decisions beyond investment performance alone.

Tax considerations are part of that picture. But they shouldn’t be the only factor driving investment decisions.

Understanding the Wash Sale Rule

One of the most important considerations when tax-loss harvesting is the IRS wash sale rule. Under this rule, if you sell an investment at a loss and purchase the same or a “substantially identical” investment 30 days before or after the sale, you generally cannot deduct that loss at that time.

This creates a 61-day window that investors need to consider.

For example, imagine selling shares of a stock at a loss, only to purchase those same shares two weeks later. The IRS would generally consider this a wash sale, preventing you from claiming the loss immediately. In many cases, the disallowed loss is added to the cost basis of the replacement shares, delaying the potential tax benefit.

The rule can also apply to purchases you may not have made intentionally.

Automatic dividend reinvestment is one example.

Reinvesting dividends can be a convenient way to purchase additional shares over time. However, if those dividends are used to purchase substantially identical shares within the wash sale window, they could interfere with a tax-loss harvesting strategy.

Transactions in other accounts, including certain retirement accounts and a spouse’s account, may also trigger wash sale rules. Special treatment applies when replacement shares are purchased in an IRA.

This is where careful coordination becomes important.

Can You Harvest a Loss and Stay Invested?

Tax-loss harvesting doesn’t necessarily mean moving your money to cash and waiting for the market to recover. In some cases, an investor may sell an investment at a loss and purchase a different investment that provides similar market exposure without being substantially identical.

The goal is to maintain an investment strategy that aligns with your long-term objectives while realizing a loss for tax purposes.

After all, trying to predict the market’s next move is not the purpose of tax-loss harvesting. Moving in and out of the market based on short-term expectations can introduce risks that have little to do with the original tax-planning opportunity.

When Is the Right Time to Consider Tax-Loss Harvesting?

November and December are natural times to review investment gains and losses. As the calendar year comes to a close, investors often have a clearer picture of their realized gains and broader tax situation.

However, market volatility can occur at any point during the year, and a temporary decline in an individual investment may create an opportunity worth evaluating.

This can be particularly relevant for investors with concentrated stock positions, significant realized gains, or an upcoming financial transition.

For example, someone preparing to sell a business, exercise stock options, or make changes to a concentrated portfolio may benefit from considering how available capital losses fit into a broader, multi-year tax strategy.

There are also trade-offs to consider. Selling an investment and purchasing a replacement may change your portfolio’s risk exposure or cost basis, potentially affecting taxes when the replacement investment is eventually sold.

Ultimately, the question comes down to how tax-loss harvesting fits into your overall financial plan.

A Year-Round Approach to Wealth Management

Market declines can be uncomfortable, particularly when headlines are focused on uncertainty. But seeing red in your portfolio doesn’t always mean there is nothing productive to do.

Tax-loss harvesting is one way we look for opportunities during market declines, always with a client’s broader financial plan in mind. The goal isn’t to predict what the market will do next, but to make informed decisions based on the opportunities available today.

This is also where a proactive financial advisor can make a difference. Rather than waiting until year-end or for a client to ask about tax-saving opportunities, an advisor should continually review portfolios, identify opportunities, and consider how investment decisions may affect a client’s tax situation.

At Morton Brown Family Wealth, we believe wealth management is an ongoing process, not simply an exercise reserved for year-end. Tax-loss harvesting is just one of the ways we consider how investments and financial planning work together.

When was the last time your financial advisor talked with you about tax-loss harvesting? If you’re unsure how tax considerations factor into your investment strategy, let’s start a conversation.