tax-loss-harvesting

What this skill does

# Tax-Loss Harvesting

## Purpose
Execute a complete tax-loss harvesting (TLH) workflow from candidate identification through post-harvest monitoring. Provides decision criteria, quantitative thresholds, replacement security selection logic, wash-sale compliance tracking across accounts, and household-level coordination that go beyond the overview in the tax-efficiency skill.

## Layer
5 — Policy and Planning

## Direction
both

## When to Use
- Scanning a portfolio for unrealized losses that exceed a materiality threshold
- Building a gain/loss budget for the current tax year to determine target harvest amount
- Selecting replacement securities that maintain factor exposure without triggering wash-sale rules
- Tracking the 61-day wash-sale window across taxable, IRA, and spouse accounts
- Generating a TLH trade list coordinated with rebalancing
- Calculating the after-tax value of a proposed harvest including state taxes and NIIT
- Monitoring replacement positions and planning swap-back timing after the wash-sale window closes
- Preparing TLH opportunity summaries for client reviews

## Core Concepts

### Candidate Identification
Scan the portfolio for positions with unrealized losses that meet all three filters:

- **Materiality threshold:** Minimum absolute loss (e.g., $2,000) or minimum loss-to-value ratio (e.g., loss exceeds 5% of position market value). Harvesting a $200 loss on a $50,000 portfolio is not worth the operational cost.
- **Holding period filter:** Positions held less than 31 days may not have meaningful losses and create short-term wash-sale complexity. Positions approaching the one-year mark (days 335-365) may benefit from waiting to convert a short-term loss into a long-term loss only if the position is expected to continue declining.
- **Loss magnitude ranking:** Rank candidates by Tax Benefit = Unrealized Loss * Applicable Tax Rate. Prioritize short-term losses (taxed at ordinary rates up to 37%) over long-term losses (taxed at capital gains rates of 15-20%) when gain/loss budget allows.

### Gain/Loss Budgeting
Before harvesting, build the year-to-date tax budget:

1. **Realized gains YTD:** Sum all short-term and long-term capital gains already realized (including fund distributions).
2. **Planned gain exposure:** Estimate gains from pending rebalancing trades, planned liquidations, or expected fund capital gain distributions.
3. **Loss carryforward balance:** Check prior-year unused capital loss carryforwards (these offset gains before new harvests do).
4. **Target harvest amount:** Target Harvest = (Realized Gains YTD + Planned Gains) - Loss Carryforward - $3,000 ordinary income offset. Harvest at least this amount to zero out the current-year tax bill; harvest more to build carryforward for future years.

### Replacement Security Selection
The replacement must maintain market exposure without being "substantially identical":

- **ETF-to-ETF swaps:** Switch between funds tracking different indices (e.g., Vanguard Total Stock Market to Schwab Broad Market, or S&P 500 to Russell 1000). Different index methodology is generally sufficient.
- **Individual stock replacement:** Replace a single stock with a sector ETF or a peer company. Example: sell Apple, buy Technology Select Sector SPDR (XLK).
- **Tracking error budget:** The replacement should have a correlation of 0.95+ and tracking error under 2% annualized relative to the original holding. Wider tracking error is acceptable for larger tax benefits.
- **Expense ratio delta:** Ensure the replacement does not have meaningfully higher expenses. A 10 bps cost increase on a $100K position held for 30 days costs roughly $8 — negligible against a $2,000+ tax benefit.

### Wash-Sale Compliance
The wash-sale rule (IRC Section 1091) disallows a loss if a substantially identical security is acquired within the 61-day window (30 days before + sale date + 30 days after):

- **Cross-account scope:** The rule applies across ALL accounts owned by the taxpayer: taxable brokerage, Traditional IRA, Roth IRA, 401(k), HSA, and spouse's accounts. A purchase in any of these accounts triggers wash-sale disallowance.
- **IRA wash-sale trap:** If a wash sale is triggered by a purchase in an IRA, the disallowed loss is permanently lost — it cannot be added to the IRA cost basis. This is the most dangerous wash-sale scenario.
- **DRIP suspension:** Automatic dividend reinvestment (DRIP) in the sold security or a substantially identical fund must be suspended during the 61-day window. Reinvesting even a small dividend triggers a partial wash sale.
- **Spouse coordination:** Purchases in a spouse's accounts (including retirement accounts) trigger wash-sale rules. Both spouses' automatic investments, 401(k) contributions, and DRIP settings must be reviewed.

### Execution Planning
Translate candidates into an actionable trade list:

- **Lot selection method:** Use Specific Identification (Spec ID) to select the highest-cost-basis lots first (HIFO). This maximizes the realized loss per share sold. If only partial harvesting is needed, sell only the lots with cost basis above current market price.
- **Coordination with rebalancing:** If the portfolio also needs rebalancing, combine TLH sells with rebalance sells to reduce total trade count. A position that is both overweight and at a loss is the ideal candidate — the harvest and rebalance are the same trade.
- **Timing strategy:** Year-end harvesting (October-December) captures the full year's losses but faces market timing risk. Opportunistic harvesting throughout the year during drawdowns of 5%+ captures losses that may recover by year-end.
- **Trade list fields:** Security, account, action (sell/buy), shares, lot IDs, estimated loss, replacement security, wash-sale window start/end dates.

### Tax Savings Calculation
Quantify the dollar value of each proposed harvest:

- **Federal rate selection:** Short-term losses offset short-term gains first (up to 37% ordinary rate). Long-term losses offset long-term gains (15-20% rate). Net losses of either type can cross over to offset the other, then up to $3,000 offsets ordinary income.
- **State tax impact:** Most states tax capital gains as ordinary income (rates 0-13.3%). Include state tax savings in the calculation; for a California resident at the 13.3% bracket, state tax roughly doubles the benefit of each harvest.
- **NIIT interaction:** The 3.8% Net Investment Income Tax (IRC Section 1411) applies to the lesser of net investment income or MAGI exceeding $250,000 (MFJ). Harvested losses reduce net investment income, potentially eliminating NIIT exposure.

### Post-Harvest Monitoring
After executing the harvest:

- **Wash-sale window tracking:** Maintain a calendar of open wash-sale windows with security identifiers and expiration dates. Flag any pending purchases (including automated ones) that would violate the window.
- **Replacement performance:** Monitor tracking error between the replacement and original security. If the replacement significantly underperforms (>3% divergence), evaluate whether the tax benefit justified the swap.
- **Cost basis updates:** Verify that broker statements reflect the new (lower) cost basis on replacement securities. The replacement's basis equals purchase price, not the original security's basis.
- **Swap-back timing:** After the 31st day, the investor may sell the replacement and repurchase the original security if desired. Evaluate whether the swap-back itself triggers a taxable gain on the replacement position.

### Household-Level Coordination
TLH across a household with multiple accounts requires centralized tracking:

- **Account type matrix:** Taxable accounts are the only accounts where TLH generates direct tax benefits. Retirement accounts have no realized gains/losses for tax purposes, but they can trigger wash sales in taxable accounts.
- **Advisor-managed vs held-away:** If the client has accounts at other institutions (401(k) plan, outside brokerage), t