EXCHANGE-TRADED FUNDS

How to harvest tax losses in pursuit of portfolio efficiency

Scott T Davis John Finneran Leslie Geller Max McQuiston

Published onMarch 3, 2025

ETFs are able to take advantage of a tax preference that may not be available in other vehicles. This can be particularly beneficial when it comes to tax-loss harvesting and capital gains considerations.

 

There are very few ways to put a positive spin on market volatility and net loss for investors. But one option that may provide some relief is tax-loss harvesting, or selling one investment at a loss to offset gains on the sale of another to reduce the tax impact. Although it's not a replacement for investment results, tax-loss harvesting can soften losses for investors facing capital gains taxes. Short-term capital gains, for assets held less than a calendar year, are typically taxed at the shareholders' federal income tax rate. In 2025, this was as much as 37% for those individuals in the highest federal tax bracket. These capital gains could also face local taxes. Long-term capital gains, for assets held for longer than a calendar year, could generally be taxed up to 20%. Taxes could be higher when including other considerations, such as Medicare or assets that are exceptions, such as coins or art.1

 

Taxes can also be a drag on investment results. Tax-loss harvesting offers an opportunity to add efficiency to an investment portfolio, if you replace the investment with one that’s higher quality, has a lower expense ratio or is more tax efficient — or a combination of the three. Indeed, the benefits of tax-loss harvesting can be even greater if there is a chance that gains in the future will be taxed at a lower rate than the losses are today. 

 

“The end of the year is always a good time to look back and assess potential tax liability,” says Leslie Geller, wealth strategist at Capital Group. “But at any time of year, if you have or are expecting a large capital gain, you might look to an investment portfolio to see if there are losses to harvest to help mitigate them. Tax-loss harvesting can be a great strategy if it makes sense in terms of the client’s overall financial picture.”

 

Geller recommends careful consideration of the strategy before making a move. By selling an asset at a loss, an investor misses out on future potential gains. Furthermore, the timing of tax-loss harvesting can be tricky, and finding quality replacement assets is key. If you are considering tax-loss harvesting for your clients, here are a few things to know.

Tax-loss harvesting basics

 

As a strategy, tax-loss harvesting is pretty straightforward: You sell an investment that has lost value, re-invest the proceeds, and use the capital loss to offset capital gains on another investment (today or in the future). But some complex details can make all the difference in the strategy’s success.

 

For example, there’s a pecking order. Long-term losses must first be applied to long-term capital gains before they can be applied to short-term gains, and vice versa. If an investor’s losses exceed capital gains at the end of the year, the losses can be applied to offset up to $3,000 of ordinary income tax. Even if investors have no gains to offset this year, or have losses greater than current gains, today’s taxable losses can be carried forward to reduce taxes in the future. (To be sure, the strategy works best when there are gains to realize in the same year.)

 

Then there is the waiting period. Tax-loss harvesting can be used on different types of investments, from individual equity securities to mutual funds and exchange-traded funds (ETFs). If you sell this type of investment at a loss, however, you may not buy the same (or a “substantially identical”) investment back within 30 days. Under the Internal Revenue Service’s wash-sale rule, there would be no capital loss if the same security is purchased within 30 days before or 30 days after the sale. The wash-sale rule does not apply to cryptocurrency holdings, which can also be harvested for losses.

Graphic of a timeline labeled “61-day wash sale period.” The timeline starts 30 days before the sale of an investment and ends 30 days after. A sale is not recognized for tax purposes if you purchase the same investment within 30 days of selling it.

Source: Internal Revenue Service

Optimizing your replacement investments

 

While some portfolio managers might hold a replacement investment just long enough for the wash-sale period to end before repurchasing the initial investment, tax-loss harvesting provides an opportunity to consider other options to replace that investment in favor of something entirely new. Selecting those replacement investments — for the short and the long term — can be key to the strategy’s success.

 

For example, a strategic investment swap may help in:
 

  • Shifting away from individual or concentrated holdings in favor of mutual funds or ETFs to increase portfolio diversification
  • Maintaining your asset/geographic/style exposure, but with investments that you believe are better suited for your portfolio in the long term
  • Moving from investment vehicles that are less focused on tax efficiency to those that are more tax efficient
  • Reducing passive index funds at the core of portfolios in favor of active core holdings
  • Lowering investment expenses

 

While expense ratios are important, taxes can be even more of a drag on investment results. If you compare the average net expense ratios from Morningstar’s universe of investment products, including mutual funds, index funds and ETFs, to their tax cost ratios (which Morningstar uses to measure how much the annualized return is reduced by taxes2), it’s clear that taxes have more of an impact on long-term gains than fees.

There are many ETFs and mutual fund options that are not substantially identical, which makes it easy to swap one investment for another during the wash-sale period and beyond, without significantly changing the portfolio allocation or profile. With an increasing number of ETFs offering similar asset profiles as diversified mutual funds, with both passive (which aim to track the risk/return profile of an index and rebalance on the same schedule as their underlying index) and actively-managed options, more advisors are considering ETFs as one solution for re-investing harvested positions in taxable portfolios.

ETFs for tax-loss harvesting, explained

 

Along with being generally lower cost investments, ETFs tend to be tax efficient, because investors buy and sell them in a secondary market, like a stock exchange. This helps insulate ETFs from the trading activity of individual investors. Investor redemptions from ETFs do not generally create taxable events for remaining shareholders. This can be an important source of tax efficiency, and make a difference in returns over the long term.

 

In 2024, just 5% of equity ETFs paid out capital gains, according to Morningstar3 — even active ETFs can be more tax efficient than other actively-managed investments.

 

Actively-managed ETFs can offer the oversight of experienced professionals, helping to manage downside risk and volatility. As with any actively-managed investment, it’s important to consider the manager’s approach, transparency, track record and consistency, along with taxes and fees. 

 

ETFs are not completely without tax drag, however. The IRS taxes ordinary dividends and interest payments on ETFs as ordinary income, just as they would income from the underlying stocks and bonds. And capital gains are realized when you sell an ETF, just as with any other type of investment.

 

“While providing more precision around tax planning can be an effective way to demonstrate your value to clients,” says Geller, tax-loss harvesting may not be right for every investor. “You are effectively just deferring your gain.” Kicking that can down the road can be the best tax solution in some cases. But there are other ways to reduce your tax bill, including charitable giving, Geller says.  

 

In cases where tax-loss harvesting makes sense, it can provide an opportunity to rethink the position. ETFs are worth considering among other replacement assets to help improve the efficiency of the overall portfolio.

“Capital Group uses tax-loss harvesting where appropriate, to further improve the likelihood of low or even zero capital gain distributions.”

Scott T Davis, ETF Director at Capital Group 

How to identify the clients that may benefit most from tax-loss harvesting

 

Depending on the complexity of your clients' portfolios and tax needs, harvesting losses may not be right for every client. So, how can you identify the clients that may benefit most from tax-loss harvesting? 

Look at your book of business. Who has invested most in recent years? Sorting your book by clients who have added the most cash to their accounts over the last 12 or 24 months, or since the most recent market cycle peak, can help determine who may have the highest cost basis for securities or funds in their portfolios. 

 

Screen your portfolios for serial capital gain distributors. These funds may present opportunities to realize losses — and potentially offset gains in other areas of the portfolio — while avoiding an unexpected tax bill from required capital gain distributions that can even occur when markets (and/or the fund) are down. 

 

Evaluate whether a portfolio's investments fit a client's tax needs. For tax-sensitive clients, using tax-loss harvesting to shift into a more tax-efficient vehicle, such as an ETF, can help pursue greater tax efficiency. This can help avoid potentially significant taxable capital gain distributions that may lead to difficult conversations with clients, especially in a down market. Some ETFs may distribute capital gains in certain years for various reasons, but an ETF with a long-term and tax-efficient investment approach would likely remain as tax efficient as possible despite the distributions.

“For the bulk of financial advisors, tax-loss harvesting is typically a fourth-quarter concern because that's when clients receive their capital gain estimates for the year from their advisors. But tax-loss harvesting should be a year-round activity. We're seeing some financial advisors make this at least a monthly review for their clients as part of a tax-savings strategy. Advisors should be asking, are there gains and losses we can be realizing right now rather than just pushing off to Q4.”

John Finneran, ETF Sales Specialist at Capital Group 

Proactively seeking tax-loss harvesting opportunities could also have an impact on your business, McQuiston says. He recalls one advisor who contacted a client's certified public accountant for a tax-loss harvesting discussion. The CPA was thrilled to talk, and said no financial advisor had ever reached out to him on a mutual client's behalf. After that, the CPA started referring tax clients to the advisor. “Showing that he would go the extra mile for his client really made an impression,” McQuiston says.

Scott_Davis

Scott T Davis is an ETF director at Capital Group, home of American Funds. He has 18 years of investment industry experience and has been with Capital Group for 17 years. Prior to his current role, Scott led product development across Capital Group. Earlier in his career he held various strategy and finance roles for Capital Group, Hostess Brands and Boeing. He holds an MBA from University of Southern California and a bachelor's degree in management science from University of California San Diego. Scott is based in Los Angeles.

headshot-john-finneran

John Finneran is an ETF sales specialist at Capital Group, home of American Funds. He has 18 years of investment industry experience and has been with Capital Group for four years. Prior to joining Capital, John worked as an iShares leader at BlackRock/iShares. Before that, he was a sales executive at Vanguard. He holds a bachelor's degree with a double major in marketing and management and a minor in international business from Villanova University. John is based in Harleysville, Pa.

Leslie-Geller-color-600x600

Leslie Geller is a wealth strategist at Capital Group. She has 18 years of industry experience and has been with Capital Group for six years. Prior to joining Capital Group, Leslie was a partner at Elkins Kalt Weintraub Reuben Gartside LLP. She received an LLM in taxation from New York University School of Law, a juris doctor from Boston College Law School and a bachelor’s degree from Washington and Lee University. Leslie is based in Los Angeles. 

max-mcQuiston-headshot-600x600

Max McQuiston is an advisory-practice management consultant at Capital Group. He coaches and provides practice management consulting insights to top financial professionals, helping advisors meet both their goals and those of their clients. He has 31 years of investment industry experience and joined Capital Group in 2014. Earlier in his career at Capital, he was a wealth management consultant covering Utah and Southern Nevada. Prior to joining Capital, he worked as a senior vice president at Fidelity Investments. Before that, he was an advisor at Raymond James and a wholesaler at Hartford. He holds an MBA from Brigham Young University and a bachelor’s degree in economics from Weber State University. He also holds the Certified Investment Management Analyst®, Certified Financial Planner™ and Retirement Management Advisor® designations. Max is based in Kaysville, Utah.

5 strategies to maximize tax efficiency with ETFs
Three ways for financial professionals to implement ETFs
ETF tax efficiency, explained

1 U.S. Internal Revenue Service

 

2 Per the SEC's guidance, after-tax returns are calculated with the highest tax rates prevailing at the time of the distribution, as if the investor were in the highest tax bracket (37% maximum federal tax rate on capital gains and ordinary income). Because Morningstar uses after-tax returns to calculate the tax cost ratio, those assumptions also apply to the tax cost ratio. Therefore, the tax cost ratio is an estimate of what investors may have experienced. Investors in lower tax brackets will not experience the full tax costs implied by the tax cost ratio.

 

3 Source: Morningstar, 2024.

 

©2025 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.
Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and should not be considered advice, an endorsement or a recommendation.
All Capital Group trademarks mentioned are owned by The Capital Group Companies, Inc., an affiliated company or fund. All other company and product names mentioned are the property of their respective companies.
Use of this website is intended for U.S. residents only. Use of this website and materials is also subject to approval by your home office.
Capital Client Group, Inc.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.