What is tax-loss harvesting?

Tax-loss harvesting is a strategy used in taxable investment accounts to reduce the taxes you owe by realizing (or “harvesting”) investment losses.

While it may sound technical, the idea is simple: when an investment declines in value, you can choose to sell it at a loss and replace it with a similar asset. You can then use that loss to offset taxable gains elsewhere in your portfolio. In some cases, those losses can even reduce a portion of your ordinary income. The goal isn’t to make short-term market moves, but rather to be thoughtful about managing your long-term tax plan.

How does tax-loss harvesting work?

When you harvest a tax loss, that realized loss can offset gains from other investments sold at a profit. If your losses exceed your gains, you can generally use up to $3,000 per year to reduce ordinary income. Any remaining unused losses can be carried forward to future years.
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For example, imagine you sell one investment and realize a $5,000 gain. If another investment in your portfolio is down $5,000 and you decide to sell it, your loss can offset the gain leaving you with no taxable capital gain between those two sales. You stay invested by replacing the sold investment with a similar, but not identical, holding to avoid triggering the IRS “wash-sale” rule.
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The benefit to tax-loss harvesting isn’t eliminating taxes altogether; it’s deferring your tax liability over time so that more of your money stays working for you.

Why does tax-loss harvesting matter?

Tax-loss harvesting can be helpful in several ways:

• Increases tax efficiency. It gives you a way to reduce the tax drag in your portfolio, especially in years with sizable gains or large fund distributions.
• Can improve after-tax returns. While it doesn’t guarantee better performance, it can enhance the net amount you keep over time.
• Provides flexibility in future years. Carryforward losses can be used strategically as part of a long-term tax plan with retirement distributions, business income, or future investment gains.

Tax-loss harvesting isn’t about market timing or trying to predict downturns. Instead, it’s about being consistently thoughtful with the aspects you can control: taxes, costs, and staying invested.

When does using tax-loss harvesting make sense?

This strategy is typically used in taxable accounts. It doesn’t apply to retirement accounts like IRAs or 401(k)s because gains in those accounts aren’t taxed annually.

Tax-loss harvesting is most effective when:

• You have meaningful unrealized losses in taxable holdings
• You expect future gains or taxable distributions
• There are suitable investments available to replace the sold position
• You’re working within a broader, long-term financial plan

Tax-loss harvesting is not a standalone tactic that should be deployed without intention. It’s one tool among many that can support a thoughtful, tax-aware investment strategy.

How does Wealthquest use direct indexing to enhance tax-loss harvesting?

For qualifying clients and accounts, Wealthquest may use direct indexing as part of our tax-aware portfolio management. Direct indexing allows us to replicate the broad exposure of an index—such as the S&P 500—by owning many of the individual stocks directly instead of holding them inside a single mutual fund or ETF.

This approach can create more opportunities for tax-loss harvesting. Because each stock experiences its own ups and downs, we can identify individual positions within the index that have declined in value—even if the index as a whole has risen. That level of precision simply isn’t possible inside a traditional index fund, where gains and losses are blended together.

Direct indexing also allows us to:

• Harvest losses more efficiently and more frequently, when appropriate
• Avoid wash-sale conflicts between funds holding similar securities
• Maintain consistent market exposure by swapping individual positions as needed

Not every account is a good fit for direct indexing, and not every client needs this level of customization. We typically discuss this strategy with clients who have larger taxable accounts, a desire for tax-sensitive management, or specific investment constraints that benefit from a more tailored approach.If you’d like to explore whether tax-loss harvesting or direct indexing makes sense for your situation, our advisory team is here to help guide the conversation.