WHAT IS
TAX HARVESTING?

Two types of tax harvesting exist: tax loss harvesting and tax gain harvesting. In this article, we will explain what both of these terms are, why you might want to consider engaging in them, and how they might be incorporated into your investment strategy.

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Capital gains tax (CGT) is a fundamental element of investing. While you cannot avoid paying CGT on eligible returns, there are strategies available to optimise your portfolio for tax efficiency, and to potentially minimise your CGT burden.

Tax treatment differs across jurisdictions.

You should consult a qualified tax adviser to confirm how relevant tax rules apply to your specific situation before making any financial or investment decisions.

What Is Tax Harvesting?

Tax harvesting is the practice of structuring your assets and portfolio in a way that offers the most favourable tax regime, often in order to reduce your capital gains tax liability.

If you are a high-income earner in a higher tax bracket, it might be that the rate of capital gains tax on investments is also relatively high. Whatever your personal situation, many people opt to structure their investment activities in a way that reduces their CGT liability. Tax gain harvesting is a means of making the most of your capital gains personal allowance. The annual capital gains tax-free allowance changes all the time, so check what your current allowance is.

While tax loss harvesting can be a beneficial strategy to lower your tax bill, it should serve as a bonus rather than the main reason for buying or selling assets. Tax considerations should never be the guiding principle behind investment decisions, and investors should always stick to their overall strategy when it comes to exiting a position. Tax harvesting is simply a potentially beneficial strategy that can be considered upon the sale of any asset.

Tax harvesting should be an optimisation strategy, not an avoidance strategy, as tax optimisation is legal, but tax avoidance is illegal. Besides, rushing to sell an asset solely to save on capital gains tax (CGT) could lead to regret if the asset appreciates in value later.

For those seeking an optimisation strategy, it is worth knowing that two types of tax harvesting exist: tax loss harvesting and tax gain harvesting. Let’s consider these in more detail.

What Is tax loss harvesting?

Tax loss harvesting describes the process of purposely selling assets that have incurred losses before the end of the tax year, in order to offset capital gains to minimise overall tax liability.

This practice, which may be used by both institutional and retail traders, allows investors to preserve their portfolio value. By selling losing trades and reinvesting the proceeds, investors can defer or potentially eliminate capital gains taxes, as the registered losses can offset tax obligations from investments which recorded a capital gain.

It is essential for those considering tax loss harvesting to understand the regulations and their implications. For example, take the “wash sale” rule, a legal regulation on offsetting capital gains. In the US, the IRS states that when selling a loss-making asset, you cannot repurchase the exact same security at a discount (typically within a 30-day period) in the hope of then making gains. Doing so, will most definitely, at the very least, make you ineligible for a reduction in capital gains tax.

What does tax loss harvesting look like in practice?

So, what does tax loss harvesting look like in practice, and how can investors use it to minimise their capital gains tax burden? Let’s consider a hypothetical example.

Imagine that an investor has earned a £10,000 return on Tesla (TSLA) stock in one year, and plans to cash in on those gains by selling the stock. To optimise their tax liability, they might engage in year-end tax loss harvesting by evaluating their overall portfolio and selling a different position that has incurred a £2,500 loss. In this instance, the investor can offset this loss against the £10,000 profit from Tesla. Consequently, the taxable amount for CGT decreases to £7,500.

These examples are simplified and for illustrative purposes only; actual liability depends on personal circumstances and local laws.

What are the Advantages and Disadvantages of Tax Harvesting

Is tax loss harvesting worth it? This will depend on how the key advantages and disadvantages relating to tax loss harvesting align with your overall financial goals and investment strategy.

What Is Tax Gain Harvesting?

Tax gain harvesting describes the process of intentionally selling profitable investments in order to realise capital gains before the end of the tax year.

The purpose of tax harvesting is to strategically sell assets with accrued gains (that would theoretically be subject to CGT) at the right time, in order to realise gains in a lower tax environment or before anticipated rate changes.

Tax gain harvesting can also be used to reset the cost basis of any position in an investor’s portfolio. By realising gains and then reinvesting in the same or a similar asset, investors can establish a new (higher) buy-in for the position. When the investment is eventually sold, the capital gains liability is, therefore, reduced. The process is one you might consider if you anticipate your capital gains tax from the sale of an asset to be lower this year than it will be in the following year.

What does tax gain harvesting look like in practice?

What does tax gain harvesting entail, and how can investors leverage it to reduce their CGT burden? Let’s consider an example.

Imagine that an investor makes £10,000 profit from selling Apple (APPL) stock. Assessing their current year earnings, they anticipate falling into a lower income tax bracket now than they are likely to in the upcoming year, due to an expected salary increase. As UK CGT rates depend on total taxable income, which determines whether you pay the basic or higher rate., the investor might decide to sell the stock now, in order to optimise the lower tax rate that is tied to their current income. Delaying the sale to the next year could result in the applicable CGT rate being higher.

Alternatively, if an investor has incurred significant losses on one stock, selling another profitable one might be advantageous. The losses would offset any capital gains tax from the sale of the profitable investment, giving the loss-making trade a small silver lining — allowing the profitable trade to benefit from it. Conversely, waiting to sell a profitable investment in a tax year without any recorded losses would result in full capital gains tax liability on your returns.

Given that capital gains tax allowances vary by country, investors should consider how any relocation plans might influence investment decision making.

Perhaps you have read in the Autumn Budget that CGT is due to rise in the following year. If you would rather not pay more on your profitable assets, consider selling them during the current tax year while lower rates still apply.

Evaluating the net worth of tax gain harvesting involves weighing up its key advantages and disadvantages. These are some of the factors to consider:

What is a Tax Loss Harvesting Simulator?

A tax loss harvesting simulator is a tool for identifying and estimating potential tax savings on positions you hold. It could help you establish if there are potential opportunities to reduce your tax liability by selling some investments at a loss.

These simulators typically work by taking a snapshot of your current portfolio and highlighting stocks or cryptoassets that are potentially eligible for harvesting.

eToro’s tax loss harvesting simulator is currently available to residents of Denmark only. eToro cannot guarantee that closing a position will result in tax savings and has no knowledge of how relevant tax rules apply to specific investors.

You should consult a qualified tax adviser to confirm how relevant tax rules apply to your specific situation before making any financial or investment decisions.

Which Tax Harvesting Strategy is Right for You?

Choosing a tax harvesting strategy depends on your personal circumstances, current financial goals, and preferred investment strategy. Whilst tax loss harvesting is a popular tax harvesting strategy, you’ll need to assess what type of investor you are to establish if it is right for you.

You also need to carry out a thorough assessment of the tax environment you are operating in, for example, the tax year is not the same in every country. Any investor implementing a tax harvesting strategy should seek to understand the factors that apply to them, which include.

Consider tax loss harvesting if:	Consider tax gain harvesting if:
You have made substantial profits from asset sales and you want to offset your looming tax bill.	You anticipate being in a higher CGT threshold or income bracket next year compared to this year.
You have loss-making assets in your portfolio that you no longer wish to hold and would rather cut loose anyway.	You expect capital gains tax rates to rise in the next year.
You are on the precipice between the higher and lower capital gains tax allowance, and you know that making a small loss would keep you in the lower threshold.	You are currently living somewhere with lower capital gains taxes than the place you are moving to next year.
You want to sell a low-performing asset, but do not want to exit your position in that particular industry.	You have made losses from other investments that can be used to offset your tax gain harvesting sale.

Final thoughts

Tax harvesting strategies are commonly used by both individual and institutional investors who take a proactive approach to tax planning. Although tax harvesting may appear complex, a solid understanding of the basics can aid in optimising your strategy.

It is important to remember that tax harvesting can be a beneficial strategy to use upon the exit of any position but should never be the guiding principle upon which you decide to sell an asset. Investors should always stick to their overall investment strategy to manage risk and optimise returns.

Visit the eToro Academy to learn more about ways to enhance your investment returns.

FAQs

Does the “wash sale” rule apply to crypto?

The “wash sale” rule does not currently apply to taxpayers who purchase crypto, so crypto wash sales are technically legal. However, the legislation surrounding cryptoassets is constantly evolving in line with mainstream adoption and institutional investment, so it is likely that this will change in the future, with legislators working to close this loophole. Note: Crypto tax treatment varies by country and may differ from traditional securities.

On what types of brokerage accounts is tax harvesting allowed?

Tax harvesting processes only apply to taxable accounts. Retirement accounts are typically exempt, as gains and losses on these types of accounts may not be taxable events. There are also alternative tax-efficient investment schemes available. These vary from country to country, with the Investment ISA account being an option open to UK investors.

Can I harvest tax loss myself?

For these reasons and complexities, many investors seek to consult their brokers, financial or tax advisors to take advantage of tax losses on their behalf, to ensure that optimisation goes hand in hand with compliance.

In theory, yes, investors can harvest tax loss themselves, but there are significant obstacles involved. It is essential to track the cost basis of your positions, find replacement assets (those that match your investment goals, but are not materially equivalent), review and rebalance your investment portfolio regularly, and carefully adhere to the regulations to ensure that you do not engage in tax avoidance.

Is tax loss harvesting something I should be doing all year-round?

While many investors focus on tax loss harvesting at the end of the year, it can be beneficial to do it on a continuous basis Market volatility throughout the year (such as during significant market corrections) often presents more opportunities to harvest losses effectively.

Are certain instruments better for tax loss harvesting?

Yes, certain investment instruments are better suited for tax-loss harvesting due to their inherent characteristics, such as volatility, and the availability of non-identical but similar replacement options.