Tax-Loss Harvesting: Why and How

For taxable accounts tax-loss harvesting may be the most valuable portfolio management activity in which one can engage before year-end 2022. Depending on individual situations, the depth and breadth of asset market downturns this year probably offer numerous value-adding opportunities that tax consequences prohibited in prior years such as:

  • Reducing legacy and/or concentrated stock positions,
  • Rebalancing Tech-heavy portfolios for better diversification,
  • Eliminating undesired positions in favor of more favorable holdings,
  • Repositioning a growth-heavy portfolio to incorporate more value positions (or vice versa), and
  • Adapting exposures to generate more income.

Another “trick” that may accentuate the value of tax-loss harvesting, providing one starts early, is dollar-cost averaging. While many associate dollar-cost averaging with selling securities, the process also may add value exiting positions. Rarely is it better to take a larger loss and, as such, selling out of positions over multiple trading sessions could enable one to take advantage of short-term volatility. Similarly, redeploying generated funds into new positions over time, opportunistically taking advantage of downside volatility, could complement well dollar-cost averaging out of positions.

Consider the following cherry-picked example to illustrate the potential value of tax-loss selling for a portfolio with just a passing flavor of favorable timing. Assume an investor correctly read the Energy environment six months ago and decided to buy 1,000 shares of oilfield services company Schlumberger (green line in price chart below) in early April 2022 at $42 per share for $42,000. Concurrently, the same investor unfortunately decided to purchase at the same time 133 shares of Microsoft (red line) at $300 per share for $39,990. In mid-June 2022 our lucky investor analyzed the SLB move to $50 per share to be too much too soon and sold their entire 1,000 shares and booked an $8,000 gain. On their MSFT position our investor proved to be not so lucky as the stock moved to $244 per share just a few days after they sold their SLB; the investor chose to sell MSFT and created a $7,448 loss. However, from a tax standpoint this MSFT loss prospectively adds $1,788 of value to the portfolio as the loss almost entirely offsets the impact of the investor’s $8,000 SLB gain, providing our investor resides in the 24% tax bracket.   

Driving our cherry-picked example just a little further, this investor also could have benefited from repurchasing the same 1,000 SLB shares four months later at $33. To maintain the symmetry to our example, they also recently reestablished their 133-share MSFT position at $244. So, our investor now not only retains the same 1,000 shares of SLB and 133 shares of MSFT, but they also have $16,868 in cash with an estimated tax liability of only $132 (24% * the $552 in gains not offset by the MSFT share sale). Additionally, the 1,000 SLB position recently reflected ~$5 per share of appreciation, offering another $5,000 in paper gains, but…with no offsetting tax-loss. Overall, our investor hypothetically finds themself an estimated $5,420 better off with the same 1,000 SLB shares and 133 MSFT shares, but with $16,868 in cash, net of the $132 in estimated taxes payable.

Event Price Shares Value Running Cash Balance Running Gain/Loss
Initial Capital       $81,900 0
March 2022 SLB purchase $42 1,000 -$42,000 $39,900 0
March 2022 MSFT purchase $300 133 -$39,900 $0 0
June 2022 SLB sale $50 1,000 $50,000 $50,000 $8,000
   Possible tax liability @ 24% bracket     -$1,920 $48,080 $6,080
June 2022 MSFT sale $244 133 $32,452 $80,532 -$1,368
   Possible tax liability @ 24% bracket     $1,788 $82,320 $420
July 2022 SLB purchase $33 1,000 -$33,000 $49,320 $420
September 2022 MSFT sale $244 133 -$32,452 $16,868 $420
September 2022 MSFT sale $38 1,000 $38,000 $16,868 $5,420


Final Portfolio Price Shares Value
September 2022 SLB holiding $38 1,000 $38,000
September 2022 MSFT holding $244 133 $32,452
Cash     $16,868
   Realized gains     $552
   Tax liability     -$132
   Unrealized gain     $5,000
Total portfolio value     $87,320
Net realized and unrealized gains     $5,420