Consider a client who owned shares in a successful private company.
The stock appreciated significantly over the years, and there was no immediate plan to sell. Like many private company shareholders, the client had substantial wealth tied to an asset they could not easily control or liquidate.
At the same time, we were managing a portion of the client's taxable portfolio using a more active tax management strategy, including direct indexing.
Rather than owning an index through a single ETF or mutual fund, direct indexing allows an investor to own many of the individual securities that make up an index. That creates more opportunities to identify individual positions trading below their purchase price, sell them, and reinvest the proceeds while maintaining similar market exposure.
Over time, that process allowed us to build a meaningful bank of realized capital losses.
Then the client's situation changed.
The private company was acquired by a public company in a taxable transaction. The client did not choose the timing of the sale, but the transaction forced the recognition of a substantial capital gain. Fortunately, the planning had started well before the acquisition was announced. The capital losses we had accumulated in the taxable portfolio could be used to offset a portion of the gain from the private company stock, reducing the client's taxable capital gain from the transaction.
That is an important lesson in financial planning: some of the most valuable planning opportunities are created before you know exactly when you will need them.
What Is Tax Loss Harvesting?
Tax loss harvesting involves selling an investment for less than its purchase price and realizing that loss for tax purposes.
Capital losses can generally be used to offset capital gains. If losses exceed gains, up to $3,000 of net capital losses can generally be used against ordinary income each year, with remaining losses carried forward for use in future years.
For an investor who expects future capital gains, those carryforward losses can become a valuable tax asset. The challenge is that losses are not always available when you need them. Markets may decline sharply in March and recover by December. An individual stock may fall temporarily while the broader index remains relatively unchanged.
If tax planning only happens once a year, many of those opportunities can disappear before anyone acts on them.
Why Direct Indexing Can Create More Opportunities
Suppose an investor owns an S&P 500 index fund.
The fund itself may be up for the year even though dozens or hundreds of the individual companies inside the index are trading at losses. Because the investor owns one fund, there may be no loss available to harvest. With direct indexing, the investor owns many of the individual securities instead. That allows the portfolio to potentially harvest losses from individual holdings while maintaining diversified market exposure. The proceeds can generally be reinvested into other securities or a similar portfolio, subject to wash sale rules.
Over time, repeated harvesting can build capital loss carryforwards that may later be available to offset gains from:
• Selling a concentrated stock position
• A private company liquidity event
• Employer stock
• Real estate or other capital assets
• Rebalancing an appreciated portfolio
The objective is not to generate losses simply for the sake of generating losses. It is to use market volatility more deliberately within the client's broader tax and investment strategy.
The Client Could Not Control the Gain
This particular situation is a good example of why planning ahead matters.
The client had not decided, "This is the year I want to sell my private company stock." The decision was made for them when the company was acquired.
Once the transaction occurred, the gain became a current tax issue. At that point, it would have been difficult to suddenly manufacture enough investment losses to meaningfully offset the gain. The available opportunities depended on what had happened in the portfolio months and years earlier.
Because tax loss harvesting had already been part of the investment strategy, the client entered the transaction with losses available. The strategy was useful not because we predicted the acquisition. It was useful because the portfolio had been managed with enough flexibility to respond when the client's circumstances changed.
Tax Management Should Be Coordinated With Investment Management
Tax loss harvesting is not simply a tax exercise.
Selling investments can change the portfolio's exposure, create transaction costs, affect future gains, and potentially trigger wash sale issues if substantially identical securities are repurchased too quickly. There is also an important economic tradeoff. Harvesting a loss generally reduces the cost basis of the replacement investment. In many cases, this means taxes are being deferred rather than eliminated. That can still be valuable.
Deferring a gain may allow the investor to use the loss against a particularly large taxable event, control when future gains are realized, or potentially take advantage of different tax circumstances later.
However, the decision needs to make sense within the entire financial picture.
The Value of an Ongoing Process
Effective financial planning is not about trying to predict when a company will be acquired or when the market will decline.
It is about understanding what risks and opportunities already exist in a client's financial life and putting strategies in place that can help when circumstances change. A client with significant holdings in private company stock may have a very different need for tax loss harvesting than someone whose wealth is primarily held inside retirement accounts.
A deep understanding of what is important to our clients makes a difference.
At ClearGuide Wealth, our established process of regularly reviewing clients' investments, taxes, business interests, equity compensation, and future goals allows us to identify opportunities that may not have an immediate payoff but could become valuable later.
Sometimes the right strategy is a Roth conversion. Sometimes it is planning around an ISO exercise or an upcoming RSU vest. And sometimes it is harvesting investment losses today because we know there may eventually be a significant capital gain somewhere else in the client's financial life.
Our role is not simply to react when a taxable event occurs. It is to continually evaluate the client's situation so that when circumstances change, the planning has already begun.