John H. Robinson, Financial Planner (May 2025)

Tax loss harvesting (TLH)-the practice of selling depreciated assets to offset capital gains and reduce tax liability-is widely promoted as a cornerstone of tax-efficient investing. Proponents claim it generates “tax alpha,” or incremental after-tax returns, often citing annualized benefits of 1% or more. However, academic research and critical analyses, including work by economist Michael Edesess, reveal significant limitations and overstatements in these claims.

The Tax Alpha Mirage

At its core, TLH offers a temporary tax deferral, not permanent savings. Selling a losing position generates an immediate tax deduction, but reinvesting the proceeds resets the cost basis lower, increasing future capital gains taxes upon liquidation. As highlighted in a 2019 Kitces.com analysis, this creates a “government loan” that must eventually be repaid. For example:

• Harvesting a $6,000 loss saves $900 in taxes (15% rate), but if the asset later recovers, the $6,000 gain incurs a $900 tax bill.
• The net benefit hinges on reinvesting the tax savings and compounding returns before the gain is realized-a scenario dependent on market performance and timing.

Academic Skepticism

1. Michael Edesess’s Critique
   In his 2014 paper, The Tax Harvesting Mirage, Edesess dismantles the notion of TLH as a universal alpha generator. Key arguments include:
   • Wash Sale Complications: Avoiding “substantially identical” securities during the 30-day wash sale period forces investors into imperfect substitutes, introducing tracking error and potential underperformance.
   • Threshold Limitations: Harvesting small losses (e.g., <5%) often fails to offset transaction costs and short-term gain taxes from frequent trading.
   • Overstated Benefits: Industry claims of 1%+ annual tax alpha ignore the long-term cost basis reset. Edesess’s simulations show a more modest 0.14–0.17% benefit, far below robo-advisor marketing claims.
2. MIT and SSRN Research
   A 2020 MIT study acknowledged TLH’s potential but emphasized its variability:
   • Annual tax alpha ranged from 0.57% to 2.29% between 1926–2018, heavily dependent on market conditions.
   • Benefits vanish if investors lack capital gains to offset, as losses can only be carried forward.
3. Centura Wealth Advisory
   A 2024 whitepaper found TLH’s post-liquidation tax alpha to be just 0.22–0.34% annually under typical capital gains rates, noting that “the benefits are greater if tax rates are higher, but diminish with smaller losses or lower returns.”

The Behavioral Trap

TLH preys on investors’ aversion to taxes, often prioritizing short-term savings over long-term outcomes. Studies show investors:

• Prefer tax-free bonds even when taxable alternatives yield higher after-tax returns.
• Overlook the irreversible basis reduction, which may increase future taxes for heirs (unless assets receive a step-up in basis at death).

When Does TLH Work?

Research identifies narrow scenarios where TLH adds value:

• Permanent Tax Avoidance: Donating harvested assets to charity or holding until death eliminates capital gains, making the tax deferral permanent.
• Tax-Rate Arbitrage: Harvesting losses at a higher marginal rate (e.g., 37%) and realizing gains at a lower rate (e.g., 15%) creates a net benefit.
• Volatile Markets: Frequent price swings increase loss-harvesting opportunities.

Conclusion

While tax loss harvesting can enhance after-tax returns in specific contexts, its benefits are often overstated and context-dependent. Academic work by Edesess and others underscores that TLH is not a free lunch but a complex trade-off between immediate savings and future liabilities. Investors should approach TLH with realistic expectations, recognizing that its value diminishes without careful planning, favorable tax rates, or strategic asset disposition. As Edesess concludes, “The tax alpha mirage distracts from more reliable wealth-building strategies-like minimizing fees and maintaining diversification.”

For my two cents, I submit that there are three tactics that many wrap-fee portfolio management platforms (including robo-advisor platforms) apply to create the appearance of value for the fees they charge.  One is the practice of including a dozen or more ETFs or mutual funds in a single account, the second is offering automatic rebalancing, and the third is tax-loss harvesting.  The evidence is thin that the value from these tactics is enough to significantly outweigh the cost of active management. Readers may accurately surmise that I am skeptical of the value of wrap-fee portfolio models.  The appearance of optimization is not the same as optimization.  In my experience, complexity is the enemy of efficiency. 

See my related post – How Many ETFs (or Mutual Funds) Do You Really Need?

John H. Robinson is the owner/founder of Financial Planning Hawaii and Fee-Only Planning Hawaii. He is also a co-founder of fintech software maker Nest Egg Guru and the new personal finance website NestEggPF.com. 

Sources

• Edesess, M. (2014). The Tax Harvesting Mirage. Advisor Perspectives.
• MIT/SSRN (2020). An Empirical Evaluation of Tax-Loss Harvesting.
• Kitces, M. (2019). Calculating The True Benefits Of Tax Loss Harvesting.
• Centura Wealth Advisory (2024). Tax Harvesting Whitepaper.

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