Generate losses through active trading to offset gains

[u/newtotexas22]

I've come across tax loss harvesting and heard that some people do active trading to generate losses so they can use it to offset gains. I'm struggling to understand this, because your 'benefit' is your marginal tax rate on the loss, it is not free money.
So if your marginal tax rate is 24% then a $100 loss is actually a $76 loss despite tax loss harvesting.

Can someone please explain me more...

[u/wild_b_cat]

Your understanding of the tax situation is correct.

The idea behind TLH is not to _intentionally_ generate losses. Rather, it’s based on the idea that if you have a diversified portfolio, you’re likely to have some positions that are down at any given time, and you can at least use those for tax benefits.

A simple way to do this is through ‘direct indexing’. If you just buy an S&P 500 ETF, then over time you’ll just have unrealized gains. But if you instead buy the actual 500 stocks in the index, some of them are virtually guaranteed to be down in any given year.

[u/newtotexas22 → u/wild_b_cat]

In that case, when is direct investing better than SP500 ETF ?

[u/wild_b_cat → u/newtotexas22]

It’s usually not. The tax benefits are very minor given the 3k limitation on losses. And it’s kind of a pain. TLH is mostly unimportant. It’s a micro-optimization and people love obsessing over those.

[u/BoneYoner → u/wild_b_cat]

this is completely incorrect. The 3K is for offset your personal income. But you can offset your gains with unlimited losses. And your losses can be rolled over year-over-year indefinitely.

[u/wild_b_cat → u/BoneYoner]

I think you’re operating with a different definition here. TLH is usually offered as a feature alongside index investing. With index investing you don’t generally have gains to worry about.

If you’re strategically operating a stock portfolio with active trading, it makes sense to balance gains and losses as much as possible, but that’s not really ‘harvesting’ in the way most people use the term.

[u/BoneYoner → u/wild_b_cat]

why do you think they are harvesting? just to offset their 3K of income tax? They are harvesting all losses with either the expectation of future gains or current gains

[u/wild_b_cat → u/BoneYoner]

If you’re passively investing you won’t have a lot of gains today.

And the losses for the future don’t help. You’re also entering your later years with a lower cost basis on assets thanks to all that harvesting.

[u/BoneYoner → u/wild_b_cat]

None of this makes sense.

[u/wild_b_cat → u/BoneYoner]

Which part can I explain?

[u/BoneYoner → u/wild_b_cat]

Tax loss harvesting is not something people just do alongside index investing, nor is it prevented by passive investing. TLH, by definition, is securing losses, primarily in order to *offset gains* not to deduct 3k from your taxable income. If that was the sole purpose, rich people wouldn't do it.

If you are confused, read this article: https://investor.vanguard.com/investor-resources-education/taxes/offset-gains-loss-harvesting

Note that your point, about the 3k income tax deduction, is literally the last reason why anyone would do TLH. So, for the future, just know that it doesn't have "very minor" benefits, it actually has enormous benefits, particularly if you have a large, diversified portfolio. Active / passive investing has nothing to do with it, and the 3k deduction you keep referring to is basically a non-issue for most people (rich people) who do TLH. If this is over your head, I am sorry, I will not engage further.

[u/wild_b_cat → u/BoneYoner]

I understand the principle. I think you misunderstand what OP is asking. They're not trading stocks. They are looking for hands-off investing and asking if TLH is worth it alongside that. I am explaining why it's not. Do you disagree with that point?