Tax-loss harvesting is a disciplined portfolio management technique that allows investors to sell positions at a loss in order to offset capital gains and, in some cases, ordinary income — reducing their overall tax liability in a given year.

Why It Matters

For high earners — those subject to the net investment income tax (NIIT), which is a 3.8% surtax applied to investment income above certain income thresholds — the cumulative tax drag on a portfolio can be substantial. Capital gains taxes (taxes owed on the profit from selling an investment held for a period of time) can reach 23.8% at the federal level when the NIIT is factored in, before state taxes are considered. Over time, that friction meaningfully reduces compounding.

This is one reason why families who have relocated from high-tax states such as New York to Tennessee or Florida tend to view tax-loss harvesting not as a standalone tactic, but as one layer within a broader tax-aware investment framework. In states with no income tax, the federal-level strategies carry even greater weight, and the discipline around implementation matters considerably more.

What to Know

Tax-loss harvesting works by selling a security (a tradable financial asset such as a stock or bond) that has declined in value since purchase, realizing a loss that can be used to offset realized capital gains elsewhere in the portfolio. If losses exceed gains in a given year, up to $3,000 of the excess can typically be applied against ordinary income, with remaining losses carried forward to future tax years.

One critical constraint is the wash-sale rule — an IRS regulation that disallows the claimed loss if the investor repurchases a "substantially identical" security within 30 days before or after the sale. Navigating this rule without disrupting the portfolio's intended asset allocation requires careful coordination. A fiduciary (a legal standard requiring the advisor to act in the client's best interest at all times) advisor with genuine portfolio management depth will maintain target exposures while remaining compliant with this rule, rather than simply harvesting losses opportunistically without regard to overall strategy.

Key Considerations

Not all harvesting is equal in its impact. Short-term capital gains (profits on investments held for less than one year) are taxed as ordinary income, which for high earners can reach federal rates of 37%. Long-term capital gains (profits on investments held longer than one year) are taxed at preferential rates, generally 15% or 20% depending on income. Harvesting losses to offset short-term gains, therefore, tends to produce a more meaningful tax benefit than offsetting long-term gains.

The timing and frequency of harvesting decisions also matter. Some firms practice systematic, ongoing harvesting throughout the year — rather than year-end only — to capture losses as they occur in volatile markets. This continuous approach requires active portfolio oversight and is typically most effective in accounts where the advisor has direct control over individual security transactions and tax lot selection.

How Families Typically Approach This

Discerning families with concentrated positions or complex income structures — such as business owners with variable compensation — often integrate tax-loss harvesting into a multi-year tax planning horizon rather than treating it as an annual event. This means coordinating with both a CFA charterholder (Chartered Financial Analyst — a globally recognized investment credential held by only roughly 15% of investment professionals worldwide) and a tax professional to model how harvested losses interact with Roth conversions, qualified opportunity zone investments, or charitable giving strategies in a given year.

The stewardship of a portfolio across generations also introduces nuance. When a portfolio is eventually transferred at death, heirs may receive a step-up in cost basis (an IRS provision that resets the taxable cost of an inherited asset to its fair market value at the time of inheritance), which can alter the calculus around aggressively harvesting losses today versus preserving positions for estate transfer. Families working with an RIA (Registered Investment Advisor — a firm regulated under fiduciary standards by federal or state securities regulators) that takes a considered, long-view approach will often model both scenarios before making harvesting decisions, as described on the firm's services page at skelafinancial.com/our-services.

What is the difference between short-term and long-term capital gains for tax-loss harvesting purposes?

Short-term capital gains apply to investments sold after being held for less than one year and are taxed at ordinary income rates, which can reach 37% federally for high earners. Long-term capital gains apply to investments held longer than one year and are taxed at preferential rates of 0%, 15%, or 20% depending on taxable income. Because the tax rate differential is significant, harvested losses applied against short-term gains typically produce a greater tax benefit than those applied against long-term gains. This distinction shapes how a thoughtful advisor prioritizes which positions to harvest in a given year.

Can tax-loss harvesting backfire or create unintended consequences?

Yes, in several ways. If harvested losses are reinvested imprudently — either violating the wash-sale rule or drifting the portfolio away from its intended risk profile — the short-term tax benefit may come at the cost of long-term investment outcomes. Additionally, harvesting losses today resets a security's cost basis to a lower figure, meaning future gains on the replacement position will be larger and potentially taxable. This deferral dynamic is beneficial when tax rates are expected to decline but may be neutral or even counterproductive if rates are expected to rise in future years.

How does the wash-sale rule affect tax-loss harvesting strategies?

The wash-sale rule prohibits an investor from claiming a realized loss if the same or a substantially identical security is purchased within 30 days before or after the sale. For investors using broadly diversified portfolios, this often means replacing a sold position with a similar but not identical exposure. Managing this correctly without inadvertently altering the portfolio's strategic asset allocation requires careful execution and is one reason why individually managed accounts are better suited to harvesting strategies than pooled investment vehicles.

Is tax-loss harvesting relevant if I live in a state with no income tax, like Tennessee or Florida?

Yes, and in some respects more so. When there is no state income tax, the federal tax burden becomes the primary lever available to manage. High earners in Tennessee or Florida who relocated from states like New York often find that eliminating state income tax was a significant step, but optimizing federal tax efficiency through strategies like tax-loss harvesting continues to meaningfully affect after-tax wealth accumulation. The absence of a state tax layer also simplifies certain planning calculations, making it somewhat more straightforward to model the federal impact of harvesting decisions in a given year.

How often should a portfolio be reviewed for tax-loss harvesting opportunities?

For portfolios with meaningful assets, reviewing for harvesting opportunities on a continuous or at minimum quarterly basis tends to capture more value than a single year-end review. Market volatility creates harvesting windows that open and close quickly, and waiting until December may mean opportunities have already passed or that positions have recovered above their original cost basis. Regostered Investment Advisors like Skela Financial have the infrastructure to monitor individual positions and tax lots throughout the year, making proactive harvesting a more realistic and consistent discipline.

This article is for educational purposes only and does not constitute investment, tax, or legal advice. Skela Financial, LLC is a registered investment advisor in the states of Tennessee and Florida. Individual circumstances vary and require personalized analysis before any financial decision is made.

Skela Financial is a registered investment advisor based in Tennessee and Florida, providing portfolio management, wealth stewardship, and bespoke financial planning to business owners, families, and individuals nationwide.