Over the last two decades, ETFs have seen tremendous growth and investor appeal. In addition to providing easy diversification and market access, ETFs are also used to facilitate tax-loss harvesting. In this strategy, an investor sells securities (stocks, bonds, or funds) that are down to realize a loss, which can then be used to offset realized capital gains and up to $3,000 of regular income. If an investor recognizes more losses than gains, or has already offset the $3,000 income cap, current rules allow for losses to be carried forward indefinitely.1
Notably, the sale proceeds can be used to purchase ETFs with similar exposures as a way to stay invested. In some cases, investors view these positions as temporary by selling them in the following year and reverting to their original investment.
To ensure that investors don’t get a tax break and then instantly buy back their original investment, the government has what’s known as the “wash sale” rule. The rule mandates that an investor cannot claim a loss on the sale of an investment and then buy a “substantially identical” security for the period beginning 30 days before and ending 30days after the sale.
While the practice of tax-loss harvesting may seem routine in nature, 2023 demonstrated three critical lessons when implementing the strategy:
First, 2023 illustrated the importance of staying invested after harvesting a loss. In the last two months of the year, U.S. equities returned ~14% (See figure below), an almost historic rally leading into year-end. Investors who temporarily parked assets into cash would have missed out on material gains, highlighting the importance of staying in the market.
