Tax-loss harvesting

When one holding is showing a loss and another has a gain you will be taxed on, tax-loss harvesting is the idea of realising the loss so it can cancel part of the gain. It is a legitimate, ordinary piece of tax mechanics — but it is easy to overrate, so this sets out how it works and where it bites. It explains a mechanism only: the exact rates and holding periods are set by tax law and can change at any budget, so treat none of the detail here as a current figure.

What it actually is

A loss on a fund you still hold is only on paper — the tax system ignores it until you sell. Harvesting is the act of selling to realise that loss, which turns it into a number the rules recognise. That realised loss can then be set off against a realised capital gain elsewhere in your holdings, so the gain that is actually taxed is smaller. Nothing is saved by the loss existing; the saving comes only from realising it and setting it off.

How set-off works

The rules sort gains and losses into short term and long term by how long you held the units. As a mechanism: a short-term capital loss can be set off against a capital gain of either kind, while a long-term capital loss can be set off only against a long-term capital gain. Capital losses cannot be set off against ordinary income such as salary. That is the shape of it; the holding-period boundary between short and long, and the rates on what remains, are fixed by law and are exactly the parts that move at a budget — the mechanism here does not depend on any particular number.

Carrying a loss forward

If your realised losses in a year are more than the gains available to absorb them, the unused part is not wasted: it can be carried forward to set off against gains in later years, for a number of years the rules specify. The usual condition is that you file your income-tax return on time and report the loss, so the record exists to be carried. Miss the filing and the carry-forward can be lost, which is the sort of avoidable slip worth knowing about in advance.

The pitfalls

Harvesting has a few traps that cancel much of its appeal if ignored:

• You must genuinely sell. A paper loss does nothing; only a realised one counts, so harvesting means actually redeeming the units.
• Selling has its own costs. Redeeming recent units can attract an exit load, and you are briefly out of the market between selling and buying back, which is its own risk.
• Do not let the tax tail wag the dog. Realising a loss on a holding you would otherwise keep, purely to save tax, can cost you more in a missed recovery than it saves. Harvesting fits best when you were rebalancing or exiting the holding anyway.

Keep the record

Harvesting is only as good as the paperwork behind it. Your capital gains statement is what reports the realised gains and losses that feed your return, so it is the document to check before and after you act. Because the rules and rates here change from time to time, confirm the current position with a qualified tax adviser rather than relying on the mechanism alone.