How To Help Clients Use ETFs for Tax-Loss Harvesting

Tax-loss harvesting with exchange-traded funds (ETFs) is a valuable tool that can benefit clients, potentially produce tax alpha (or increased after-tax returns), and support them through higher-income tax years.  

What Clients Need To Know About ETF Tax-Loss Harvesting 

Tax-loss harvesting involves selling an investment that has declined in value to “harvest,” or realize, the loss from the purchase date (basis) to the sale date. These losses can be used to offset gains from other investments, up to $3,000 of ordinary income taxes each year, or carried forward to offset future gains.

Tax-loss harvesting isn’t a market timing strategy; it’s a common tax management strategy designed to produce a loss that’s useful for current or future tax planning.

The Benefits of ETFs for Tax-Loss Harvesting

ETFs are a common tool for tax-efficient portfolios—they offer unique advantages when implementing a tax-loss harvesting strategy, including the following:

• Low turnover: Unlike mutual funds, ETFs generally have lower turnover of internal investments and don’t distribute significant capital gains at year-end.
• Intraday trading: ETFs can be sold quickly and replaced easily in most trading systems.
• Transparency and substitution: ETFs offer highly specific exposures, allowing advisors to research and identify replacements within the same asset class without triggering the wash sale rule or changing the portfolio’s overall risk profile.

Let’s go through these and other advantages in more detail:

ETFs’ Built-In Tax Advantages Over Mutual Funds

ETFs have a creation and redemption process that allows authorized participants to exchange shares for underlying securities without triggering taxable events within the fund. This helps ETFs avoid distributing capital gains to shareholders, unlike mutual funds, which often pass through taxable distributions even when you’re trying to harvest losses.

In addition, when you harvest losses with mutual funds, you risk receiving an unexpected capital gains distribution at year-end that could partially offset your harvested loss. ETFs seldom distribute capital gains, making your tax-loss harvesting calculations more predictable and reliable.

Operational Advantages for Harvesting

ETFs trade throughout market hours at transparent, real-time prices. This allows you to execute tax-loss harvesting trades immediately as prospects arise, rather than waiting for end-of-day mutual fund pricing that could move against you.

This also means that you can harvest the exact loss amount you need. If a client needs $10,000 in losses to offset gains, you can execute the trade when the ETF hits that precise loss threshold, rather than hoping the mutual fund’s end-of-day price delivers the target amount.

Replacement Options That Avoid Wash Sale Rules

Perhaps most importantly, when harvesting losses from individual stock positions, ETFs enable clients to sell a declining individual stock and immediately replace it with an ETF that offers exposure to the same asset class or sector, thereby maintaining the client’s market position and avoiding wash sale violations. This approach is particularly worthwhile for clients with concentrated single-stock positions who want to diversify while capturing tax benefits.

This can also be done to capture losses from shares in other ETFs. For example, you might harvest losses in a broad market ETF and replace it with a similar but not “substantially identical” ETF tracking a different index, as required by the IRS.

The variety of factor-based and style-specific ETFs allows for nuanced replacements. You can maintain small-cap value exposure, for instance, while switching between different small-cap value ETFs with distinct selection criteria or between active and passive ETFs aimed at the same geography or sector.

Key Times for Strategic Harvesting

Tax-loss harvesting isn’t appropriate or necessary for each client, every year. It’s a tool ready to be utilized in the right situations, potentially including the following:

Offsetting Large Gains

Many of my tech executive clients come to me with sizable single-stock positions that are highly concentrated and appreciated. Selling these positions can result in potentially substantial tax bills. Harvesting ETF losses in the same year can cut that burden—unlocking proceeds for diversification and liquidity goals.

Likewise, clients who are selling real estate properties, a business, or other appreciated assets may want to be more aggressive about tax-loss harvesting in a year they may be realizing gains elsewhere. 

Volatility-Driven Opportunities

Market swings can open the door for tax-loss harvesting, even if there isn’t a significant gain to offset in the current year. Losses can be carried forward indefinitely on a tax return and used to offset the gain from a future sale of an appreciated asset.

A temporary drawdown in an ETF allows for the realization of a loss, while still keeping clients invested through replacements. 

Long-Range Tax Planning

After completing a financial plan, you can often spot larger expected changes to future tax brackets. If your client has a higher income and falls into the 20% capital gains tax rate plus the 3.8% net investment income tax, and their income will drop in a future year, harvesting losses now, even knowing your client will owe capital gains tax in a future year, might make sense if you expect the capital gains rate to drop to 15% or even 0%.

Building a Tax Planning Foundation

Tax-loss harvesting is most effective when you understand your client’s goals, values, biases, and preferences. It should be integrated into a broader, thoughtful intake and planning process—one that starts with good fact-finding and a clear understanding of each client’s tax preferences and tax tolerance.

Every client has a different emotional and financial response to taxes. Some are comfortable realizing gains and paying tax in exchange for long-term simplicity and diversification goals. Others may prefer to delay gains, even if it means a more complex portfolio. Simply asking clients how they feel about taxes can lead to better planning decisions, stronger buy-in, and fewer surprises at tax time.

Take the time to loop in your client’s accountants or tax preparers early, especially when harvesting losses (or realizing significant gains), to align all planning professionals across their financial advisory team. Tax-loss harvesting should be in sync with other tax planning moves, such as Roth conversions, charitable giving, and real estate sales, as well as sensitive issues like the brackets for Medicare income-related monthly adjustment amounts.

Implementing ETF Tax-Loss Harvesting in Your Practice

Tax-loss harvesting is most effective when it’s proactive, repeatable, and well-coordinated across the team.

Best practices include the following:

• Create tasks in your CRM tools or trading software to identify and monitor ideal tax-loss harvesting opportunities.
• Systematize your process. Create CRM tags or fields to track clients ideal for harvesting, and use workflow steps and automated tasks.
• Maintain a list of suitable replacement ETFs for each core portfolio position. Quick options reduce the amount of ad-hoc research necessary while trading portfolios.
• Document your rationale for each harvest to explain the reasoning for the trades and why an investment was sold at a loss. Clients may need a reminder why you sold an investment while it was down, that it was a tactical move meant to serve a larger goal.
• Train the team and assign roles, workflow steps, and tasks within your CRM system.
• Prepare clients by explaining the tax value of tax-loss harvesting and what to expect.
• In my CRM, we use a tag for “wins” to log moments where we’ve saved a client money or helped them move forward on a difficult task or process. It reinforces the value we deliver and helps build long-term trust.

Harvesting Losses Today to Enable Gains Tomorrow

Some of the most impactful tax-loss harvesting work occurs in years when clients are making significant moves—selling stock, exercising options, or disposing of property. In these years, capital gains can spike, and clients may feel paralyzed by the tax bill—a well-timed harvest acts as a pressure valve, creating a path to diversify further.

Losses harvested now can be carried forward indefinitely and used to offset gains in future years. For clients with large concentrated positions, this creates a longer runway for systematic diversification with less tax friction.

The Bottom Line

Tax-loss harvesting with ETFs can improve your client relationships and reduce their future tax bills when executed effectively. The goal is to assess and support your clients’ broader goals: diversifying away from risky positions, reducing tax drag on a portfolio, and aligning the portfolio with the longer-term goals.

It’s a clear tool advisors can use to demonstrate proactive planning. While adding alpha through investment selection is tough, adding tax alpha through strategic harvesting is possible, measurable, and meaningful to your clients.