The year-one tax saving is mostly a loan from the tax authority. What is left after the lower cost basis is taxed, and the two cases where harvesting is worth much more.
Much less than the tax saved in the year of harvest, unless the loss offsets short-term gains or the position is held until death. Harvesting an illustrative 3,000,000 of losses on a 50,000,000 portfolio saves 714,000 of tax at 23.8 per cent, a "tax alpha" of 1.43 per cent, but the lower cost basis gives that 714,000 back on sale: if the portfolio is sold after ten years at 7 per cent, the net gain is 526,196, about 6 basis points a year. With a step-up in basis at death it is 1,404,546.
Worked in full in The Family Office Professional by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Tax-loss harvesting sells positions trading below cost, realises the loss to offset gains elsewhere, and immediately buys a similar but not substantially identical security so that market exposure is unchanged. Direct indexing platforms and family office managers report the result as tax savings in the year. That number is real cash, but it is mostly a loan from the tax authority, repaid when the replacement securities, now carrying a lower basis, are eventually sold.
| Input | Value |
|---|---|
| Portfolio, cost basis equal to value at the start | 50,000,000 |
| Losses harvested in year 1 | 3,000,000 |
| Return, a year, all as price growth | 7% |
| Long-term gains rate (20% + 3.8% net investment income tax) | 23.8% |
| Short-term gains rate (37% + 3.8%) | 40.8% |
| Horizon before sale | 10 years |
The replacement securities are assumed to earn the same return as those sold, and the tax saved is reinvested at the same 7 per cent. State tax is ignored. This illustrates mechanics, not tax advice.
Tax saved = 3,000,000 × 23.8% = 714,000; as a share of the portfolio, 1.43%
This is the figure usually reported. Reinvested at 7 per cent for ten years it grows to 1,404,546 (1.0710 = 1.9672), and that side pot carries tax of 164,350 on its own growth when sold.
The harvested positions were replaced at the lower price, so the portfolio's basis is now 47,000,000 instead of 50,000,000. When it is sold at 98,357,568 in year ten, the gain is 3,000,000 larger and the tax 714,000 higher.
Net benefit = side pot after tax − extra exit tax = (1,404,546 − 164,350) − 714,000 = 526,196
After-tax wealth: 87,374,663 with harvesting, 86,848,467 without; 6.0 basis points a year
All figures are in year-ten money, undiscounted.
In Excel, with the loss in B1, the rate now in B2, the rate later in B3, the return in B4 and years in B5: =B1*B2*((1+B4)^B5*(1-B3)+B3)-B1*B3.
What remains is the return on an interest-free deferral, and nothing else. The 1.43 per cent of the first year becomes 1.05 per cent of the starting portfolio over a decade.
| Case | Tax saved now | Net benefit | Share of portfolio | A year |
|---|---|---|---|---|
| A. Offsets long-term gains, sold in year 10 | 714,000 | 526,196 | 1.05% | 6.0 bps |
| B. Offsets short-term gains, sold in year 10 | 1,224,000 | 1,412,050 | 2.82% | 16.1 bps |
| C. Offsets long-term gains, held until death | 714,000 | 1,404,546 | 2.81% | 14.2 bps |
| D. Offsets short-term gains, held until death | 1,224,000 | 2,407,793 | 4.82% | 24.2 bps |
Two things turn a deferral into a permanent saving. The first is rate arbitrage: a loss that offsets short-term gains taxed at 40.8 per cent and is repaid later at the 23.8 per cent long-term rate saves 510,000 for good, on top of the deferral. Losses net first against gains of the same holding period, so the arbitrage needs a short-term loss, on a position held a year or less, and short-term gains to absorb it, from hedge funds, active managers or option overlays. The second is the step-up in basis at death: if the replacement securities are never sold in the owner's lifetime, the extra tax is never paid and the whole saving, with its growth, is kept.
Horizon cuts both ways in case A. A sale after three years leaves 122,439, 7.0 basis points a year; after twenty years, 1,561,303 but only 4.9 basis points a year, because the benefit as a share of wealth levels off while the years keep adding up.
The deferral logic is the same one behind tax drag on a taxable portfolio, and the step-up is what makes buy, borrow, die work.
A harvested loss is an interest-free loan from the tax authority: 714,000 saved here becomes a net 526,196 if the portfolio is sold in ten years, about 6 basis points a year. It is worth well over twice as much where it offsets short-term gains or where the family will hold until death, and over four times as much when both apply. The Family Office Professional covers how an office organises tax and investment decisions together, and the free workbook for the book shows when running such an office pays.
Usually not. Replacing the sold securities at a lower price lowers the cost basis, so the tax saved now is paid back when the portfolio is sold. In the illustrative case 714,000 is saved and 714,000 more is paid in year ten; the net benefit of 526,196 is the return earned on the deferred tax.
When the loss offsets short-term gains taxed at 40.8 per cent and is repaid later at the 23.8 per cent long-term rate, or when the position is held until death and receives a step-up in basis. On 3,000,000 of losses those cases are worth 1,412,050 and 1,404,546 over ten years, and 2,407,793 when both apply.
The tax saved by harvested losses expressed as a share of the portfolio, here 714,000 on 50,000,000, or 1.43 per cent in the year. It overstates the economic benefit because it ignores the tax repaid on the lower basis later; over ten years the net figure is 1.05 per cent of the starting portfolio.
This article is one calculation from The Family Office Professional. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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