Tax-loss Harvesting

Late in the year, an adviser sells a client's losing positions to realize losses that offset realized gains elsewhere, reducing the client's tax bill. This technique is called...

1. A.Tax-loss harvestingCorrect — realizing losses to offset gains is tax-loss harvesting.
2. B.ChurningChurning is excessive trading for commissions, not tax-motivated loss realization.
3. C.Dollar-cost averagingDollar-cost averaging concerns periodic buying, not realizing losses for taxes.
4. D.Front runningFront running is trading ahead of a client order, an unrelated violation.

Why: Deliberately realizing losses to offset capital gains (and up to a limited amount of ordinary income) is tax-loss harvesting. The adviser must avoid triggering the wash sale rule when doing so.

Reviewing the trading history of a taxable account, an adviser sees that the client consistently sells positions showing a gain and holds those showing a loss. Beyond the behavioural error itself, the adviser should point out that the pattern

1. A.accelerates capital gains tax while leaving the available losses entirely unharvested.Correct. The bias moves tax forward and forgoes the offset, which is the reverse of tax-efficient practice.
2. B.reduces portfolio turnover and therefore the total transaction cost of the account.Wrong. The pattern generates a steady stream of sales, so turnover rises rather than falls.
3. C.converts what would have been long-term gains into short-term gains.Wrong. Nothing in the pattern establishes how long any position was held before it was sold.
4. D.is tax-neutral, because gains and losses offset one another over a full market cycle.Wrong. The offset never arrives, since the losses are the very positions he refuses to realise.

Why: The disposition effect has a tax consequence that compounds the investment one. Selling winners realises capital gains and brings the tax forward, while holding losers leaves losses unrealised and therefore unavailable to offset those gains or ordinary income. The result is a portfolio that pays tax earlier than it needs to and never harvests the offset that was sitting in the account the whole time. Deliberate tax-loss harvesting is the mirror image of the pattern, which is what makes the behaviour so expensive: the client is systematically doing the opposite of the tax-efficient thing.