High-income taxpayers like physicians and other professionals often face high tax bills due to bonuses, private practice income, and investment earnings. While tax-deferred accounts like 401(k)s and IRAs provide long-term tax advantages, they don’t address the ongoing tax drag that can affect taxable investment accounts.
Tax loss harvesting is one strategy that can reduce the sting of capital gains and even offset some ordinary income. When you implement tax loss harvesting correctly, it can help you preserve more of your after-tax returns and create long-term financial efficiency.
In this guide, we explain what tax-loss harvesting is, how it works, and how physicians and other high-income investors can use it effectively. We also outline some practical steps for implementing the strategy and highlight common pitfalls to avoid so you have a reliable framework for reducing your tax liability without compromising your long-term investment goals.
What is tax-loss harvesting?
To understand tax loss harvesting, you first need to understand capital gains and losses. A capital gain is the profit from selling an investment for more than its purchase price. A capital loss is the loss from selling an investment for less than its purchase price.
Tax-loss harvesting is the practice of selling investments at a loss to offset other capital gains. By harvesting those losses, you only pay taxes on your net gains for the year: the amount you gained minus any losses you realized.
For example, say Dr. Smith sells a mutual fund at a $15,000 gain and another holding at a $10,000 loss. By harvesting that $10,000 loss, she only reports $5,000 of net capital gain on her tax return.
When you harvest tax losses, ideally, you will use the proceeds from the sale to purchase an investment that fills a similar role in your portfolio. This reinvestment ensures you stay invested in the market and maintain a diversified investment portfolio.
If your capital losses exceed your capital gains, you can offset up to $3,000 of ordinary income each year. You can carry forward any unused losses beyond that $3,000 limit indefinitely, using them to offset capital gains in future tax years.
This strategy only applies to taxable accounts. Tax-deferred retirement accounts like traditional and Roth IRAs and 401(k)s are not eligible, as gains and losses within these accounts are not taxed annually.
Why tax loss harvesting matters for physicians
For high-income earners, reducing taxable income is especially valuable. Tax-loss harvesting can offset gains generated from selling all kinds of appreciated capital assets, including stocks, bonds, mutual funds, cryptocurrency, real estate, artwork, collectibles, and business assets.
If your capital gains exceed capital losses, you can use the $3,000 capital loss rule to offset other income, such as business profits, salaries and wages, quarterly or annual bonuses, and distributions from a partnership.
Physicians who invest through taxable brokerage accounts (either personally or through a trust) can benefit from harvesting losses during market downturns, rebalancing without triggering excessive tax liabilities.
A step-by-step guide to how tax loss harvesting works
It’s helpful to understand the mechanics of tax-loss harvesting so you can apply the strategy correctly. While we always recommend working with experienced financial and tax advisors, here’s an overview to help you know what to expect.
Step 1: Identify investments with unrealized losses
Start by reviewing your taxable brokerage account for positions that are worth less than what you paid for them. These may be individual stocks, mutual funds, or exchange-traded funds (ETFs).
Step 2: Sell the investment before year-end
To apply the loss on your current tax return, the sale must occur in the same tax year. It’s common for investors to review portfolios in Q4 (October–December), but you can harvest losses throughout the year if there’s a significant drop in the fair market value of an asset.
The sale triggers a realized capital loss, which you can use to offset realized capital gains or ordinary income (up to the $3,000 limit).
Step 3: Avoid the wash-sale rule
The IRS wash-sale rule disallows a loss if you buy a “substantially identical” security within 30 days before or after the sale. That includes rebuying the same security, purchasing a similar mutual fund or ETF with the same underlying holdings. For example, selling shares of Vanguard Index 500 and then buying shares of T Rowe Price Index 500 would trigger the wash sale rules, because both index funds are based on the S&P 500 index.
Wash sales can also happen when you make the purchase in another account you control, including a spouse’s or IRA account.
If you run afoul of the wash sale rules, you cannot take a loss for that security on your current-year tax return. Instead, you add the amount of the loss to the cost basis of the replacement security. The higher cost basis decreases the size of any future gains realized from the sale of the replacement security.
For example, say you buy 100 shares of ABC stock for $1,000. One year later, the market value of the stock drops, so you sell your 100 shares for $6 per share—a $400 loss. Two weeks later, ABC is trading at $4 per share. You decide the price is too good to pass up, so you purchase 100 shares for $400, triggering a wash sale.
As a result, you cannot claim the $400 loss on your current-year tax return. Instead, you add it to the cost basis of the repurchased stock. That bumps the cost basis of your $400 replacement stock up to $800 (the $400 purchase price plus $400 in disallowed losses). If you later sell that stock for $1,000, your taxable gain would be $200 instead of $600.
A wash sale doesn’t need to be intentional. For example, if you sell part of a position for tax-loss harvesting purposes and then reinvest dividends, you could lose some of your tax break.
Step 4: Document the sale and reinvestment
Keep records of the date, price, and cost basis of both the original investment and the replacement asset. Your broker may generate this information automatically, but it’s always a good idea to confirm the accuracy of any gains or losses you report on your tax return.
You report losses on IRS Form 8949 and Schedule D as part of your federal income tax return. Work with your tax advisor to ensure you report the gains and losses correctly and have proper documentation to back up your return in case the IRS or state tax authority selects your return for an audit.
Common tax loss harvesting pitfalls (and how to avoid them)
Even experienced investors can make mistakes when harvesting losses. Below are some of the most frequent issues we see taxpayers make:
- Accidentally triggering a wash sale. This is the most common error. Remember, buying a substantially identical security within the 61-day wash-sale window (30 days before or after the sale) voids the deduction. This rule applies across all your accounts, not just the one where the loss occurred.
- Harvesting too frequently. Some investors might harvest losses throughout the year, but overdoing it can increase transaction costs or interfere with long-term investment strategy. Focus on meaningful losses that can reduce your overall tax bill.
- Failing to reinvest properly. If you stay out of the market for too long after a sale, you risk missing a rebound. Consider reinvesting in a similar asset class to avoid disrupting your overall asset allocation.
- Harvesting in tax-advantaged accounts. Remember, tax-loss harvesting does not offer any benefits in tax-deferred or tax-free accounts like a 401(k) or IRA. However, buying an investment in one of those accounts can trigger the wash sale rule if you buy a substantially identical security to one sold in a taxable account.
Practical tax loss harvesting tips for physicians and high-income investors
To make the most of tax loss harvesting’s benefits, you need to approach it strategically and coordinate this tax-saving strategy with your overall financial plan. The following best practices will help you apply this strategically and avoid potentially costly errors.
Coordinate with your advisor or tax professional
Tax-loss harvesting is most effective when integrated into your year-round tax strategy. Your tax advisor can help you determine if you have gains to offset or income that could benefit from harvesting losses.
Use portfolio management tools
Many investment platforms now have automated tax-loss harvesting features. Work with your advisors to consider whether these tools can help you capture losses efficiently without violating IRS rules.
Think beyond year-end
While many investors harvest losses in December, market volatility can create opportunities year-round. Periodic reviews can help you lock in losses early.
Track your carryforward losses
If your losses exceed gains and the $3,000 annual limit for offsetting ordinary income, you can carry the remaining losses forward. These can be used in future years, so keep careful records, especially if you switch tax preparers.
Tax-loss harvesting isn’t a hack—it’s a discipline
Tax-loss harvesting is not a loophole or one-time trick. It’s a repeatable strategy that can help you optimize after-tax returns. But you have to follow the rules, avoid common mistakes, and coordinate with a qualified tax advisor.At Cerebral Tax Advisors, we help medical professionals implement proactive tax strategies tailored to their needs. If you’re ready to put tax-loss harvesting and other tax-smart tactics to work for your financial future, we invite you to schedule a free Tax Discovery Session today.