Tax-Loss Harvesting: How To Use a Bear Market To Lower Your Tax Bill

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It’s been a rough year for U.S. equities.

Due to a combination of historic inflation and aggressive interest rate hikes by the Federal Reserve, the S&P 500 has dipped at least 20% for the year on a few occasions. As of late October, it’s down more than 18.5% for the 2022 calendar year.

Some well-known individual stocks, such as Netflix (-50.5%) and Meta (-70.7%), are down even more.

However, there are silver linings for investors. If you’re still many years from retirement, you’re getting an opportunity to continue investing at lower prices.

And no matter who you are, you may be able to offset some investment gains or even your personal income through tax-loss harvesting.

Table of Contents

What Is Tax-Loss Harvesting?

Tax-loss harvesting lowers your taxable income by your decision to sell an investment or investments at a loss.

You can use the realized losses to offset investment gains or even taxes you owe on personal income.

There are rules and strategies involved with tax-loss harvesting. It can be more or less risky — and easier or harder to execute — depending on your age, the complexity of your investment portfolio, your current financial goals and other factors.

Note that selling an investment at a loss within a tax-advantaged retirement account such as a 401(k) or IRA isn’t going to lower your tax bill. You can buy and sell freely within those accounts no matter how old you are as long as you aren’t withdrawing the money.

Tax-loss harvesting becomes more popular during November and December, as people start to think about their tax bills for the year that’s about to end. But you don’t have to wait until the end of the year to practice tax-loss harvesting.

How Do I Calculate a Realized Gain or Loss?

In investing, your cost basis is the most important number.


Let’s say that you bought 10 shares of Widget Company A, priced at $100 per share. That’s a $1,000 investment. However, your broker charges you a 0.1% fee, or $10. In that case, your cost basis is $1,010 for 10 shares.

If you sell all 10 shares for $1,110, you’ve realized a gain of $100 — not $110.

And if you sell all 10 shares for $910, you’ve realized a loss of $100.

In a given calendar year, if you’re buying and selling all kinds of assets, you’re probably realizing gains and losses.

If you bought in at the peak euphoria of the market in January, before inflation, the war in Ukraine and rising interest rates caused a stock market correction, you may have a lot of assets that you can sell at a loss right now.

Is There a Limit on the Realized Losses I Can Apply to My Tax Bill?

Let’s say you’ve sold some investments at a loss this year.

You may be wondering how many dollars from those losses you can actually use to reduce your tax bill come April.

Remember, there are two ways you can reduce your taxable income.

First, you’re allowed to offset any capital gains that you’ve realized. If you’ve realized $100,000 in stock profits, you can offset that by realizing $100,000 in stock losses.

Second, if you have no capital gains to offset this year, you’re still allowed to use those losses to offset up to $3,000 of normal taxable income ($1,500 if you’re married and filing separately).


Also, you can carry over your losses to offset your taxes in future years: Your realized losses don’t expire. The IRS just limits the amount of realized losses you can apply to the income you earned each year.

In other words, let’s say you made $100,000 this year. You didn’t sell any stocks for a profit, but you did realize a $10,000 loss in your portfolio. You can apply $3,000 of that against your taxable income, lowering it to $97,000. And you can carry the other $7,000 to subsequent years ($3,000 per year).

What Is the Wash Sale Rule and Why Does It Matter?

Without some rules, tax-loss harvesting would create some giant loopholes in the U.S. tax code.

Any time you owned a stock that fell below your cost basis, you could sell it, realize a loss and buy it back immediately. You’d eventually stockpile enough realized losses to offset large long-term gains.

The wash sale rule closes that loophole. The rule states that, if you want to do tax-loss harvesting, you can’t buy the same asset — or a substantially similar one — 30 days prior or 30 days after you sell to realize losses.

If you’ve sold at a loss to lower your tax bill, you can’t buy that stock or asset inside your 401(k) or IRA for 30 days either. And neither can your spouse if you’re married and file your taxes jointly.

Perhaps the most complex part of tax-loss harvesting, these rules can be tricky.

Violate the wash sale rule, purposely or not, and you can’t use your realized losses to lower your tax bill.

The safest way to avoid a violation is to park the proceeds of a sale in cash, wait on the sidelines for 30 days and then repurchase the asset.

However, in many cases, you can skirt the rules in a legal way. Perhaps you’re selling an individual stock at a loss, and then you’re immediately buying an ETF that happens to include exposure to the same industry or sector.


If you invest with a financial advisor or do business with one of the mega-companies such as Fidelity, Vanguard or Schwab, you may be able to get some guidance on what you can and can’t re-buy immediately, money expert Clark Howard says.

Just know that you’re the person ultimately responsible for staying within the rules.

What Are Short-Term vs. Long-Term Gains and How Do They Relate to Tax-Loss Harvesting?

The IRS discourages day trading and even swing trading.

If you realize gains on investments you’ve held for less than one year, and you don’t have realized losses to offset your profits, you may pay a much larger tax.

The IRS taxes those so-called short-term gains, or profits you’ve made in less than one year, as ordinary income at your marginal tax rate for the year.

Those who reach the highest tax bracket — $539,900+ in taxable income for single filers and $647,850+ for married filing jointly — can pay up to 37% on short-term gains. Some people may even qualify for an additional net investment income tax (NIIT) of 3.8%, raising their effective tax rate on short-term gains to as high as 40.8%.

Even if, like the majority of Americans, you reach the 22%, 24% or 32% marginal tax bracket, you’re still paying significantly more on short-term gains than on long-term gains.

Here’s a chart that shows the long-term capital gains tax brackets for 2022.

Tax RateTaxable Income (single or married filing separately)Taxable Income (married filing jointly)
0%Up to $41,675Up to $83,350
15%$41,676 to $459,750$83,351 to $517,200

How Long-Term vs. Short-Term Losses Impact Your Taxes

You’ve realized losses. You intend to use those losses to lower your tax bill. What now?

If you’ve realized short-term losses, you must first use those losses to offset any short-term capital gains you’ve realized before moving to offset long-term gains and then personal income.


The same holds true if you’ve realized long-term losses. You must first offset gains of the same type.

As an example, let’s say you fall into the typical long-term capital gains tax rate of 15%. And you’ve realized a $10,000 gain. Typically, you’d pay $1,500 in taxes on that gain. If you then realize a $5,000 long-term loss, you’ve cut your taxable long-term gains to $5,000 and your taxes to $750.

What if I Invest via Dollar-Cost Averaging?

Most people don’t buy a huge amount of Amazon stock on a specific day and never touch it again. Instead, a lot of us invest a portion of our income every month or every paycheck in relatively small amounts.

This is called dollar-cost averaging: You’re not investing all your money at a market peak or a market low point.

However, when it comes to tax-loss harvesting, that can cause headaches. You have to keep track of every time you bought, your cost basis and the price of every sale, although good investment companies will help you do that with year-end tax statements.

Are There Downsides or Risks to Tax-Loss Harvesting?

Human psychology and emotion are the enemies for most investors.

No matter how rational you believe yourself to be, it’s easy to feel like you need to find quarters under the couch cushion to invest at the end of a long bull run when everyone feels euphoric and stock prices are overvalued compared to a company’s actual profits.

The opposite holds true as well. It’s easy to spot the bottom of the market in hindsight. But it often happens when things feel bleakest. Unfortunately, it’s extremely difficult to predict when markets will turn around. And most of the biggest market gains happen very soon after markets turn a corner.

So sitting on the sidelines for the wrong 30-day period can be a mistake. Even beyond that, if it’s an investment that you’ll sell years into the future — and if taxes are more expensive later than they are now, as Clark has predicted for years — resetting your cost basis to a lower amount could be a net negative, even considering your reduction in taxes now.

I don’t know about you. But there have been times in my life when I simply made a foolish investment. When I sell, I’m not looking to get back in. I’m looking to put my money elsewhere.


Those are perfect times to tax-loss harvest, because you’re not simply buying again and lowering your cost basis for when you eventually cash out.

Do Robo-Advisors Offer Tax-Loss Harvesting and Is That Valuable?

Yes. All the best robo-advisors offer automated tax-loss harvesting.

If you’re investing through an IRA or 401(k), you don’t need this service. Remember, your investments in those accounts are sheltered from taxes as long as you leave the money in those accounts.

However, mutual funds are notoriously tricky for taxes.

You’re handing your money to a fund manager at Vanguard or Fidelity or Schwab, for example, along with many other people. These fund managers constantly have to rebalance the overall portfolio. Maybe the funds are designed to hold 10% in tech stocks, but tech stocks go on an epic bull run and suddenly make up 30% of the portfolio. Or maybe a large account holder decides to cash out and the fund manager needs to sell some shares.

Since you have fractional ownership in the fund’s holdings, you are realizing gains throughout the year. This makes mutual funds less desirable in a taxable account. You don’t even have to sell mutual fund shares in order to realize gains.

However, robo-advisors automatically reduce your tax obligations via strategic tax-loss harvesting.

This is valuable to an extent — but not always to the extent for which some robo-advisors try to charge you in annual fees.

Final Thoughts

The markets are down this year in a way that hasn’t been common since the financial crisis of 2007-09. Even the crash at the onset of COVID-19 ended swiftly.

Especially if you overextended yourself in January, when the markets still seemed hot, you have a chance to make lemonade out of lemons, at least to some extent, by realizing some losses.


Tax-loss harvesting can be extremely simple — realizing a loss on a single stock, for example, in a year that you didn’t realize any gains. It can also be endlessly complex. Don’t be afraid to seek help from a certified tax pro or a fiduciary financial advisor if you need it.

And you can always play it safe if you engage in tax-loss harvesting by parking your money for at least 30 days before re-investing.

Here are other year-end strategies you can use to cut your 2022 tax bill.

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