What is tax-loss harvesting?

Harvested losses can be applied to offset both capital gains and up to $3,000 in ordinary income annually. Losses that cannot be applied in a given tax year can be carried over indefinitely to offset future income and capital gains. The benefits of TLH are higher when the offset happens earlier rather than later, and when the offset is applied to short term gains or income rather than to long term gains.

Avoiding paying capital gains tax by offsetting the gains with harvested losses does not mean that you never need to write a check to the IRS. By harvesting losses now you are simply deferring when you write the check to the IRS.

If your future tax rate for long and short term gains is lower than your current rates, you benefit by writing the check later, because that tax bill will be calculated using lower rates.

Thus, greater the differential, higher the benefit from TLH. However, in the scenario where future tax rates are higher than current, delaying payment would work to your disadvantage.

Assuming you put your TLH savings to work in your investment portfolio, the value added also depends on the expected return of your investment portfolio. The higher the returns, the higher the benefit.

Assuming you put your TLH savings to work in your investment portfolio, the value added also depends on your investment horizon. In general (assuming positive expected returns over your investment horizon) the longer you hold on to your investments, the higher the TLH benefit.

TLH involves the selling of investments that have declined in value. In general, securities with higher volatility definitionally have greater price fluctuations. As such portfolios that hold a greater proportion of risky securities have greater opportunity to harvest losses.

After selling a security to harvest losses, the cash proceeds from the sale are invested in a replacement security; while the replacement security typically has high historical correlation with the original security in the past, it is conceivable that the performance of the replacement security in the future may be better or worse than that of the original security.

Not all losses can be used to offset gains; if you buy the same or substantially identical security within 30 days of the sale in any account (including accounts outside of your Interactive Advisors account), then the IRS does not allow the offset due to the ’wash sale ^[1]’ rule. As such the benefit to TLH will be reduced.

TLH generally and the use of our TLH functionality may not be appropriate or beneficial for all investors. Investors:

1. without taxable accounts;
2. in relatively low income tax brackets;
3. expecting higher future tax rates;
4. planning to withdraw a large portion of their investments within a year; and/or
5. trading any of the ETFs in their Asset Allocation portfolio investments in non-Interactive Advisors accounts, including joint accounts, likely to trigger the wash sale rule,

will generally benefit the least from using TLH.

TLH is generally valuable for investors with taxable accounts (as tax-advantaged accounts like traditional or Roth IRA accounts are already tax-free or tax-deferred) who have a long-term investment horizon (as it works through tax deferral not tax avoidance and thus it is less beneficial over a short investment horizon). Often TLH is most effective for investors who harvest losses for use against high-rate income (i.e., short term capital gains) and convert future realized gains to long-term capital gains subject to the preferentially lower rate.

The replacement securities purchased with the proceeds from TLH sales typically have a high historical correlation with the replaced securities. Nonetheless, the performance of the replacement securities could end up being better or worse than that of the original securities and the replacement securities may cause your investments to deviate from the overall strategy of the portfolio if investment compromises are made to achieve the tax losses.

We do not monitor transactions in clients’ accounts outside of our platform, whether held at Interactive Brokers LLC or elsewhere. Clients are thus responsible for ensuring they identify and properly handle wash sales resulting from trading in their (and their spouse’s) non-IA accounts. The implementation of our TLH algorithm assumes clients do not hold or trade the ETFs held in their Asset Allocation Portfolio investments in any other account. For more information on the wash sale rule and other tax-loss harvesting-related issues, please review IRS Publication 550 open_in_new and the Interactive Brokers website open_in_new.

TLH results in increased trading in the accounts of clients who activate the functionality. Such increased trading could result in increased trading expenses, executions at less favorable prices, less favorable tax treatment of some dividends, portfolio drift, and increased risk of trading errors.

Always consult your personal tax advisor to determine whether TLH generally and our specific functionality would be advantageous in your specific financial and tax situation. The tax consequences of using TLH are complex and uncertain and may be challenged by the IRS or any other tax authority. For a more detailed discussion of associated risks and limitations, please review our disclosure presented to all clients activating the functionality for their Asset Allocation investments: Tax-loss harvesting disclosure picture_as_pdf .