A loss in your portfolio can lower your taxes. Waiting too long can erase it.

How harvesting a loss works

When you sell an investment in a taxable account for less than its tax basis, you realize a capital loss. Losses first offset capital gains of the same type: short-term against short-term, long-term against long-term. Any remaining net loss offsets the other type.

If losses exceed gains, up to $3,000 a year ($1,500 if married filing separately) can be deducted against ordinary income. The rest carries forward to future years without a time limit while you are living.

Because short-term gains are taxed at ordinary income rates, losses that offset short-term gains generally save the most. Harvesting does not apply to IRAs, 401(k)s, or other tax-advantaged accounts, where gains and losses are not reported.

Avoid the wash-sale rule

A loss is disallowed if you buy substantially identical stock or securities within 30 days before or after the sale. The window covers 61 days in total.

The rule reaches further than many investors expect:

• Purchases by your spouse can trigger it.
• A purchase inside your IRA or Roth IRA triggers it, and in that case the loss is permanently lost rather than deferred.
• Automatic dividend reinvestment can create a small wash sale.

A disallowed loss in a taxable account is usually added to the basis of the replacement shares, so it is deferred rather than lost. Many investors maintain market exposure by buying a similar but not substantially identical fund during the waiting period.

Weigh the costs and risks

• Lower basis going forward. Harvesting resets your basis lower, so more gain may be taxed later. The benefit comes from deferral and from rate differences, not from eliminating tax entirely.
• Portfolio drift. Frequent trading can pull your allocation away from your plan.
• Transaction costs and spreads can consume small benefits.
• State taxes. Florida has no personal income tax, but residents of other states may see different results.

Automated harvesting through a managed account can capture opportunities systematically. Make sure it coordinates with every account in your household, including your spouse's and your IRAs, to avoid wash sales.

What happens to gains and losses at death

At death, most inherited assets receive a new tax basis equal to fair market value on the date of death. For appreciated assets, the built-in gain disappears for income tax purposes. For assets that have declined in value, the built-in loss also disappears; the heir's basis steps down.

Capital loss carryovers generally can be used on the decedent's final income tax return but do not pass to the estate or heirs. For married couples filing jointly, the surviving spouse generally keeps only the portion of the carryover attributable to the survivor.

This creates a practical rule of thumb for older investors and anyone with a serious illness: realize losses during life when they can still be used, and consider holding highly appreciated assets so your heirs receive the basis adjustment.

Gift appreciated assets, not losers

Lifetime gifts follow different basis rules. A recipient generally takes your basis for computing gain. If the asset is worth less than your basis at the time of the gift, the recipient's basis for computing a loss is limited to the lower fair market value, so the loss can be lost.

Some practical consequences:

• Sell a declining investment and harvest the loss yourself, then gift cash if you want to help family.
• Give appreciated stock to a public charity, a donor-advised fund, or a private foundation to avoid the gain entirely while claiming a deduction, within the applicable limits.
• In low-income years, family members in the 0% long-term capital gains bracket may be able to realize gains without federal tax, a strategy sometimes called gain harvesting.

Make it part of the plan

Tell your successor trustee and agent under your power of attorney whether you want them to manage taxable accounts for tax efficiency if you become incapacitated, and give them authority to do so.

Keep basis records organized. Heirs need date-of-death values for inherited assets, and your trustee needs accurate cost basis for assets sold during administration. A good plan connects investment decisions with the people who will eventually carry them out.