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, and how they can inform your investment strategy to help you to fully optimise your capital gains.

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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.

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 minimise your capital gains tax (CGT) burden.

If you are a high-income earner, your capital gains tax payments are likely to be high. It is for this reason that so 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 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 is commonly 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 appreciated investments.

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 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, for instance, the investor can offset this loss against the £10,000 profit from Tesla. Consequently, the taxable amount for CGT decreases to £7,500.

So, is tax loss harvesting worth it? Consider the key advantages and disadvantages to assess the value of tax loss harvesting to 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 is to strategically sell assets with accrued gains (that would theoretically be subject to CGT) at the right time, in order to avoid a higher capital gains tax burden further down the line.

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.

Tax gain harvesting is a practice 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 minimise their CGT burden? Let’s consider an example.

Imagine that an investor makes £10,000 profit from selling Apple 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 is income-based, 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 could 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 change annually and vary by country, investors should consider any relocation plans when selling.

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, sell them during the current tax year so that you aren’t stung by a tax rise.

So, is tax gain harvesting worth it? Evaluate the worth of tax gain harvesting by weighing its key advantages and disadvantages against your overall financial goals and investment strategy.

Which tax harvesting strategy is right for you?

Typically, tax loss harvesting is the most popular tax harvesting strategy, but this does not necessarily mean that it is the right strategy for every investor.

When assessing tax harvesting strategies, the most important thing is to assess your personal situation in line with your financial goals and overall investment strategy, and make an informed decision about which approach is more likely to optimise your investments. It is also important to remember that the tax year is not the same in every country, and investors should seek to understand the financial calendar in applicable regions before implementing a tax harvesting strategy.

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 taxes 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. 

By being aware of your income allowance, earnings and loss-making assets, and by comprehending the relevant rules and regulations, you can effectively minimise your CGT liabilities. This approach allows you to mitigate the impact of investments that result in losses, optimise those that bring returns, while ensuring compliance with tax regulations.

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 rewards.

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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.

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.

Can I harvest tax loss myself?

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 your investment portfolio regularly, and carefully adhere to the regulations to ensure that you do not engage in tax avoidance.

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.