Here's when tax-loss harvesting makes sense … and when it doesn’t

When the stock market dips, a strategy known as tax-loss harvesting can be a silver lining. But it doesn’t make sense for all portfolios, financial experts say.  

Here’s how tax-loss harvesting works: You can sell declining assets from your brokerage account and use the losses to offset other profits. Once losses exceed gains, you can subtract up to $3,000 per year from regular income. 

Tax-loss harvesting may now be more attractive with the S&P 500 Index down by nearly 14% since January’s all-time high. However, there are scenarios where it’s better to steer clear on this strategy.

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One popular move involves selling a losing asset and replacing it with something similar to score a tax break while keeping the original portfolio exposure. 

However, this so-called wash sale rule bars that loss if you buy a “substantially identical” investment within the 30-day window before or after the sale, according to the IRS.

It may be better to consider skipping tax-loss harvesting if you can’t find a “good equivalent replacement,” said certified financial planner Matthew Boersen, managing partner of Straight Path Wealth Management in Jenison, Michigan.

While it may be easier to find alternative exchange-traded funds or mutual funds, selling individual stocks requires you to “sit on the sideline for the next 30 days,” he said.

“The market can move a lot during this time,” said Kristin McKenna, a Boston-based CFP and managing director at Darrow Wealth Management. You may potentially “wipe out the tax benefits of harvesting losses” by choosing another stock, she said.

“It’s important to consider the role of funds in an asset allocation and how selling different securities may impact risk,” McKenna added.

What’s more, if your income falls below certain thresholds, it’s better to take profits from assets owned for more than one year, known as long-term capital gains, rather than losses, explained Larry Luxenberg, a CFP and founder of Lexington Avenue Capital Management in New City, New York.

If you have taxable income under $41,675 for single filers and $83,350 for married couples filing together in 2022, you’re in the 0% bracket for long-term capital gains.

You calculate taxable income by subtracting the greater of the standard or itemized deductions from your adjusted gross income, which are your earnings minus so-called “above-the-line” deductions.

“You may actually want to take gains if you’re still in the zero capital gains rate,” Luxenberg said.

When you’re in the 0% bracket, you can sell profitable assets, avoid paying long-term capital gains taxes and repurchase the same investments for a so-called “stepped-up basis,” which adjusts the purchase price to the current value, securing lower taxes in the future, he said.