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Tax-Loss Harvesting

Tax-loss harvesting is a strategy used in investment management, including within Individual Retirement Accounts (IRAs), to improve after-tax returns. This technique involves selling securities that have experienced a loss and replacing them with similar investments to maintain the overall investment strategy. The primary purpose of tax-loss harvesting is to offset taxes on both gains and income.

In the IRA industry, tax-loss harvesting can be slightly different from its application in taxable investment accounts. IRAs, both traditional and Roth, have distinct tax treatments:

  1. Traditional IRAs: Contributions are often tax-deductible, and taxes are deferred until withdrawals are made in retirement. Since taxes are not incurred on gains or losses within the account, the concept of tax-loss harvesting as a strategy to offset capital gains tax does not directly apply.
  2. Roth IRAs: Contributions are made with after-tax dollars, and qualified withdrawals are tax-free. Similar to traditional IRAs, since investments grow tax-free, there is no immediate tax benefit to harvesting losses within a Roth IRA.

However, tax-loss harvesting can still be relevant for IRA investors in a broader portfolio context. Investors who hold both taxable accounts and IRAs might use losses in their taxable accounts to offset gains, while simultaneously adjusting their IRA investments to maintain a consistent overall asset allocation. This indirect approach allows the investor to reap some tax benefits while adhering to their long-term investment strategy.

It’s important to note that tax-loss harvesting should be done with consideration of the “wash-sale rule,” which prohibits claiming a loss on a security if a substantially identical security is purchased within 30 days before or after the sale. This rule applies across all accounts, including IRAs and taxable accounts.