Tax-Loss Harvesting Strategies for High-Net-Worth Portfolios

Executive Summary¶

Tax-loss harvesting (TLH) remains one of the most reliable sources of tax alpha available to high-net-worth investors. When executed systematically, TLH can defer---and in some cases permanently eliminate---federal and state capital gains taxes, adding an estimated 0.80--1.50 % in annualized after-tax return for portfolios above $5 million. This analysis outlines advanced harvesting strategies, wash-sale compliance frameworks, and integration with charitable giving and estate planning.

Key Takeaways¶

• A $10 million equity portfolio with 25 % annual turnover can generate $180,000--$320,000 in harvested losses per year under normal market conditions.
• Direct indexing amplifies TLH capacity by 2.5--3.0x compared to ETF-based portfolios, due to individual-lot-level loss realization.
• The IRS wash-sale rule (Section 1091) applies across all accounts held by the same taxpayer, including IRAs---a nuance frequently overlooked.
• Combining TLH with qualified charitable distributions (QCDs) and donor-advised funds (DAFs) can create a triple tax benefit: deduction on donation, avoidance of capital gains on appreciated lots, and harvested loss carry-forward.

The Mechanics of Tax-Loss Harvesting¶

Tax-loss harvesting involves selling a security at a loss and simultaneously purchasing a "substantially similar" but not "substantially identical" replacement to maintain market exposure. The realized loss offsets capital gains dollar-for-dollar and, when gains are exhausted, up to $3,000 of ordinary income annually, with unlimited carry-forward.

Quantifying the Opportunity¶

The magnitude of harvestable losses depends on three factors: (1) portfolio volatility, (2) dispersion among individual holdings, and (3) harvesting frequency.

Source: Apex Quantitative Research; based on 2015--2025 backtests with daily harvesting triggers.

The table above illustrates why direct indexing has become the preferred vehicle for TLH-oriented portfolios. By holding individual securities rather than funds, the manager can harvest losses at the lot level even when the index itself is positive.

Wash-Sale Rule Compliance¶

The 61-Day Window¶

Under IRC Section 1091, a loss is disallowed if the taxpayer purchases a "substantially identical" security within a 61-day window (30 days before to 30 days after the sale). The disallowed loss is added to the cost basis of the replacement security, deferring---but not eliminating---the tax benefit.

Cross-Account Application¶

A critical compliance consideration: the wash-sale rule applies across all accounts of the same taxpayer, including:

• Taxable brokerage accounts
• Traditional and Roth IRAs
• 401(k) and 403(b) plans (where feasible to monitor)
• Spousal accounts (under joint filing)

Apex's proprietary Wash-Sale Compliance Engine (WSCE) monitors all client accounts in real time, flagging potential violations before trade execution. The WSCE cross-references 147 holding dimensions, including CUSIP, ISIN, option underliers, and convertible-bond references, to ensure no inadvertent substantially-identical purchase occurs.

Replacement Security Selection¶

The replacement security must maintain exposure to the same asset class and risk factors while avoiding "substantial identity." Apex employs a factor-matching algorithm that targets:

• Beta within +/- 0.05 of the harvested position
• Sector exposure within 2 % of the original weight
• Tracking error < 50 bps annualized vs. the sold position's factor profile

Advanced Strategies¶

Strategy 1: Gain-Loss Matching Optimization¶

Rather than harvesting losses indiscriminately, Apex's tax overlay identifies the optimal set of losses to realize based on the character of available gains:

• Short-term gains (taxed at ordinary income rates up to 37 % + 3.8 % NIIT) should be offset first by short-term losses.
• Long-term gains (taxed at 20 % + 3.8 % NIIT) are offset by remaining long-term losses.
• Net losses exceeding gains are applied against ordinary income ($3,000 cap) with carry-forward.

For a client in the top bracket (37 % + 3.8 % NIIT = 40.8 % marginal rate on short-term gains), the after-tax value of a $100,000 short-term loss harvest is $40,800---versus $23,800 for a long-term loss. This differential drives the prioritization algorithm.

Strategy 2: Charitable Layering with Donor-Advised Funds¶

The most tax-efficient disposal of appreciated securities is donation rather than sale. By contributing highly appreciated lots (holding period > 1 year) to a donor-advised fund, the client:

1. Receives a fair-market-value deduction (up to 30 % of AGI for appreciated property).
2. Avoids realizing the embedded capital gain.
3. Frees the portfolio to harvest replacement-position losses in subsequent periods.

Example: A client holds 10,000 shares of XYZ Corp. with a cost basis of $15 and a current price of $85. A direct sale would generate a $700,000 long-term capital gain, resulting in $166,600 in federal tax (23.8 %). Donating the shares to a DAF eliminates the $166,600 tax liability and generates a $850,000 charitable deduction worth $346,800 in tax savings (40.8 % marginal rate, assuming sufficient AGI).

Strategy 3: Estate Basis Step-Up Integration¶

Under current law (IRC Section 1014), assets held at death receive a stepped-up cost basis to fair market value. This creates a powerful end-game for TLH:

• Harvest losses throughout the investor's lifetime to offset gains and ordinary income.
• Hold the lowest-basis "core" lots indefinitely; they will receive a step-up at death, permanently eliminating the deferred gain.
• Estimated permanent tax savings for a $20 million portfolio over a 25-year horizon: $1.2--$2.4 million (present value at 5 % discount rate).

Implementation Considerations¶

Risk Considerations¶

• Legislative risk: Proposals to limit or eliminate the basis step-up at death (e.g., the American Families Plan) could diminish the long-term value of TLH strategies. Current legislative outlook suggests no change before 2027 at the earliest.
• Complexity cost: Direct indexing portfolios with 500+ individual positions require sophisticated rebalancing, corporate-action processing, and tax-lot accounting. Errors can trigger inadvertent wash sales or tracking-error drift.
• State-level variability: States such as California (13.3 % top rate), New York (10.9 %), and New Jersey (10.75 %) amplify TLH benefits, while states with no income tax (TX, FL, WA) reduce---but do not eliminate---the federal-level advantage.

Outlook & Recommendations¶

For high-net-worth clients, we recommend:

1. Direct indexing as the core equity vehicle for taxable accounts above $2 million, targeting the Russell 3000 or MSCI ACWI.
2. Daily harvesting triggers with a minimum loss threshold of 2 % per lot and 30-day holding period.
3. Charitable layering for clients with annual philanthropic commitments exceeding $50,000.
4. Annual tax-projection meetings (September and December) to optimize year-end gain/loss realization and estimated tax payments.

Apex's Tax Alpha Program has generated a cumulative 8.7 % in after-tax excess return for participating clients since inception in 2019 (net of all fees and transaction costs).

This material is provided for informational purposes only and does not constitute tax advice. Clients should consult their tax advisors regarding their specific circumstances. Tax laws are subject to change. Apex Financial Partners is a registered investment adviser and does not provide legal or tax advice.