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Managing Taxes With Loss Harvesting and ETFs

Open field ready to harvest.

Many investors know the key benefits of exchange-traded funds (ETFs): lower costs, trading flexibility, transparency and tax efficiency. Fewer people are aware that ETFs also may help reduce tax bills through a strategy called tax-loss harvesting. It’s a strategy with taxable accounts that can be employed throughout the year—and useful whenever volatility strikes—to sell losing positions to offset capital gains.

Here’s how ETFs have the potential to save you money at tax time.

Market turbulence can be an opportunity to reassess your portfolio. Capitalizing on losses can help offset future gains while also giving you the ability to rebalance your portfolio. Taxes alone shouldn't drive investment decisions. But harvesting losses made in concert with an overall investment plan may ease the future tax-bill sting.

Turning Your Loss Into A Potential Win

Investment losses can be hard to swallow, but tax-loss harvesting lets you take the losses of one investment to offset the gains of another.1 According to the IRS, if your net capital loss exceeds your capital gains, the amount of the excess that you can claim to lower your income is $3,000. If your net capital loss is more than $3,000, you can carry the loss forward to later years to help lighten your future tax burden. The IRS provides guidance on the amount you can carry forward or consult with a professional tax consultant.

Consider investments that no longer fit your overall portfolio strategy or can be replaced by other investments that fill a similar role when looking for losses to harvest. After you have decided which investments to sell off or replace, you have to be aware of the specific rules about wash sales.

What To Know About Wash Sales

There are specific rules around tax-loss harvesting when it comes to choosing a replacement security. The IRS prohibits a wash sale, which is buying a substantially identical security within 30 days before or after selling a security at a loss.

Download our "Harvest Time" flyer for a framework to determine if you are dealing with substantially similar securities and for more tax-loss harvesting tips.

For more options for investors who are worried about paying higher taxes, check out American Century® Municipal Bond Funds as building blocks for a diversified portfolio.

Tax Efficiency + Cost Efficiency

Many ETFs are available on no-transaction-fee (NTF) platforms. Investors who buy an ETF on a NTF platform do not pay a ticket charge. Additional cost savings is yet one more reason to consider using ETFs when replacing a security sold at a loss.

Tax-Loss Harvesting Do's and Don'ts

Use our framework as a starting point for year-end tax planning discussions.

Long- and short-term capital gains are taxed at different rates. Long-term gains may only be offset by longer-term losses. Likewise, short-term gains may only be offset by short-term losses.

IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.

Exchange Traded Funds (ETFs) are bought and sold through exchange trading at market price (not NAV), and are not individually redeemed from the fund. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.