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Is Tax Harvesting Unfair?

Not really, but a great money spinner for tax software & brokers

Note: Since my last email, I’ve released a fourth episode of my Twitter Trade podcast here.


  • A brief explanation of how tax harvesting works

  • Laws that limit tax loss harvesting

  • A better alternative?

A brief explanation of how tax harvesting works

  1. Consider buying €50 of stock A and €50 of stock B.

  2. Next, consider that your holding of stock A drops in value to €25, while your holding of stock B rises to €75. Your portfolio is still worth the same in total (€100), but stock A has gone down and stock B has gone up.

  3. Now, consider selling stock B for €75 – realising a profit of €25.

In countries with capital gains taxes you now own capital gains tax on your realised profit on stock B – even though your portfolio as a whole hasn’t increased in value. You don’t get any mitigation from the fact that stock A is down if you haven’t realised that gain.

This, very roughly, is what tax loss harvesting aims to solve, and it goes as follows:

  1. You now also sell stock A for €25 – realising a loss of €25 on stock A.

  2. Having sold stock A, you immediately re-buy stock A for €25.

Now, the net effect is that you have realised a gain of €25 on stock B, but also realised a loss of €25 on stock A to cancel out the gain. So, by doing this selling and immediate re-buying of stock A, your overall portfolio has no net gain, and you also owe no taxes.

So, is tax harvesting fair?

On the one hand 👍:

  • Taxes can only be reduced to the extent that your overall portfolio includes losses.

  • There is no way to avoid paying taxes when realising a profit that exceeds all of the losses in your portfolio.

  • If you don’t tax harvest, there are many situations where your portfolio as a whole has lost money, but you still owe taxes on the assets where you did make profits.

On the other hand 👎:

  • Clearly there is a view that tax loss harvesting is unfair because there are laws that aim to stop it (see next section).

  • As per the example above, using tax loss harvesting aims to pay less taxes than otherwise would be paid.

My current view is that the way the system works in Ireland or the US is ok. It would be bad if tax harvesting were completely outlawed because individuals and companies would be paying taxes on specific gains even when their overall portfolio is down – a tax on diversification. However, as you’ll read below, it’s possible to limit but hard to prevent tax loss harvesting.

Laws that limit tax loss harvesting

In Ireland there is a rule that limits tax loss harvesting:

In short, this rule means that if you sell and buy a share immediately, then you aren’t allowed to apply any realised loss against other gains. This limits tax loss harvesting, but doesn’t prevent:

a. Selling an asset, waiting four weeks, and re-buying it later.

b. Selling one asset and buying another asset that behaves similarly. Legal systems take different views of what is sufficiently dissimilar to be allowable or not.

Now, governments could increase the four weeks, or try to block trades for similar assets, but this quickly starts to restrict the flow of shares/assets in the market.

A better alternative?

As I said above, where the systems in the US and Ireland have landed is ok.

It’s easy to frame tax loss harvesting as controversial for being a form of tax avoidance, but the reality is more banal.

Separately, tax loss harvesting is an example of a second order effect whereby one rule results in the need for a further rule. Instituting a capital gains tax resulted in tax loss harvesting, which resulted in a further set of rules around tax loss harvesting, which now results in further rules/interpretations around which assets are similar or not…

Capital gains taxes get complicated quickly for someone making regular trades, because it involves tracking and reconciling the entire history of transaction purchase and sale prices. All in all, this is good for tax accountants and tax software.

The imperfection of any one tax, partly explains why countries have some balance of taxes:

  • Capital gains tax – helps reallocate wealth but hurts investment/entrepreneurship and has the issues described above.

  • Value added tax (a bit like a sales tax) – has the nice property of being a tax on consumption and not investment. However, it’s regressive because the same rate applies no matter who is buying.

  • Income tax – can be built to be progressive, but has the downside that it taxes work.

  • Corporate tax – not needed in principle if you’re sufficiently taxing the shareholders on dividends and share sales, but needed in practise to capture taxes from shareholders that live abroad.

  • Wealth tax – re-allocates wealth but hurts investment/entrepreneurship and very hard to implement in practise (see my reflections on Sam Altman’s proposals).

  • Inheritance tax – I’m not getting into it.

My current view on taxes is to roughly keep the same mix, but reduce rates by eliminating deductions/exclusions (New Zealand style). BBLR – broad base low rates, as advocated for by TR Reid in his excellent book “A Fine Mess”.

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