Tax-loss harvesting in bear and bull markets

Tax-loss harvesting: the current environment

Relative to bull markets like the current one, bear markets present an abundance of opportunities for tax-loss harvesting, as stock market declines can leave holdings with market values that are lower than when an investor purchased them. It gets harder to identify such holdings in a year such as 2024; as of mid-November, the magnitude of the U.S. stock market’s year-to-date gains appeared likely to lead to a positive overall return for the full year, absent a sharp downturn in the closing weeks of 2024. It would be the second positive year in a row, following 2023’s market appreciation.

However, not all stocks have risen in 2024, and a full portfolio review is likely to turn up some holdings that have declined in value and therefore could help provide a tax to offset potential gains, if sold. For example, of the 30 stocks represented in the Dow Jones Industrial Average, 8 had negative year-to-date results through October.¹

The stock market’s most recent negative year was 2022. That year’s decline was the steepest since 2008, and it meant that investors had plenty of equity holdings in their portfolios that had generated losses, making them potential candidates to sell to help offset potential gains from other holdings that had appreciated.

Where to look in a portfolio for tax-loss harvesting opportunities

While equity allocations are often the first place that investors target when seeking holdings to offset gains and pursue tax-loss harvesting, eligible investments aren’t limited to stocks or stock funds; losses from bonds and other asset classes can be used to offset taxable capital gains as well.

For investors in mutual funds or exchange-traded funds (ETFs)—as opposed to individual securities—capital gains are triggered as portfolio managers sell holdings that have appreciated in value, based on the difference between the purchase price and subsequent sale price. The fund’s shareholders share the tax burden in the same calendar year that the net gains were realized.

It’s also important to know that tax-loss harvesting applies only to assets held in taxable accounts; in other accounts such as IRAs and 401(k)s, assets grow tax deferred² and aren’t subject to capital gains taxes in the year they occurred. The tax impact can be especially big for taxable account holders with high incomes that place them in the three top-tier tax brackets paying rates of 32%, 35%, and 37%.

The potential benefits: an illustration

While tax-loss harvesting can be complicated, it can be simple in other respects. For example, assume a fund holding that declined in value can be sold to generate a pretax loss of $10,000. That loss may in turn fully offset the net capital gain exposure from the sale of another holding whose value increased by $10,000. 

Moreover, losses may be used to help limit tax exposure from noninvestment, ordinary income such as wages, as well as to offset investment gains. Under current law, a capital loss deduction allows an investor to claim up to $3,000 more in losses than in capital gains, meaning investors can reduce their taxable income dollar for dollar, up to that $3,000 limit. (The limit is $1,500 for a taxpayer who's married and files separately.) 

However, any investor selling securities as part of a tax-loss harvesting strategy should trade cautiously to maintain eligibility for deducting any losses. An IRS restriction known as the wash sale rule makes it difficult to realize a short-term benefit from quickly getting back into a mutual fund or security after selling the investment at a loss. The loss can't be deducted unless an investor waits at least 30 days to reinvest in that same investment or one that the IRS considers “substantially identical.” If investors want to remain invested after taking the loss, they can invest in a similar investment that isn’t substantially identical.

Year end is a common time to identify opportunities

Around October or November, asset managers typically provide notices to fund shareholders to aid in year-end tax planning. These notices, as well as online disclosures, indicate which funds are expected to pay gains by year end—based on market performance at the date the estimates are made, typically through the end of September—and provide estimates of the amounts of those expected gains as well as funds’ estimated income distributions from dividends, interest, and other net income.

Although this preliminary information is subject to market movements in the closing months of the year, early estimates provide an opportunity to evaluate potential tax liability and, if merited, adjust accounts accordingly through strategies such as tax-loss harvesting. While asset managers typically don’t distribute late-year estimates of funds expected to generate losses, identifying such funds isn’t difficult. Year-to-date performance figures are widely available on the websites of asset managers and research firms, as mutual funds are required to publish share prices each business day.   

A good time to check with your financial professional and consult our resources

With all the complexities involved in tax-loss harvesting, professional advice can be especially valuable for investors with taxable accounts, as there’s no guarantee that such a strategy will achieve any particular tax outcome or that it will be in an investor’s best interest over the long run. 

In addition, the John Hancock Investment Management tax-smart investing page has resources on tax-smart strategies, including information about structural characteristics of ETFs that may offer tax-related advantages relative to mutual funds. You’ll also find information about unique aspects of separately managed accounts that offer potential benefits in pursuing tax-loss harvesting. Moreover, the John Hancock Investment Management tax center offers resources on tax planning, including our latest tax planning guide, tax forms, and more. The power of professional advice and solid information can go a long way toward helping to maximize an investor’s tax efficiency and review long-term investment goals.

1 S&P Dow Jones Indices, November 2024. 2 Tax deferral postpones the payment of taxes on asset growth until a later date—meaning 100% of the growth is compounded and won’t be taxed until withdrawn, usually at age 59½ or later, depending on the type of account or contract. Withdrawals from tax-deferred accounts are subject to ordinary income tax and, if made before age 59½, may be subject to a 10% penalty tax.