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DIV 401Lesson 9 of 9
0 of 9
  1. 1How Dividends Are Taxed
  2. 2Reading Your 1099-DIV
  3. 3How Return of Capital Is Taxed
  4. 4Section 1256 and the 60/40 Rule
  5. 5How Covered Calls Are Taxed
  6. 6How REIT, BDC and MLP Payouts Are Taxed
  7. 7Foreign Dividends and Withholding Tax
  8. 8Which Account Should Hold Your Dividends?
  9. 9Tax-Loss Harvesting for Dividend Investors
  1. Dividend University
  2. DIV 401 Taxes for Income Investors
  3. Lesson 9
DIV 401 · Lesson 9 of 9

Tax-Loss Harvesting for Dividend Investors

Turning a losing position into a tax break without giving up your income.

9 minute read Intermediate Updated

What you’ll learn

  • How selling at a loss can lower your tax bill without leaving the market
  • The order losses are used in, the $3,000 limit and carryforwards
  • The wash sale rule, including the traps from automatic reinvestment and IRAs
  • How to swap between similar funds and keep your income flowing

Every investor ends up with some losers. In a taxable account, a losing position has a silver lining: selling it can cut your tax bill. Done carefully, you can harvest that loss while keeping your money invested and your dividend income flowing. That’s tax-loss harvesting.

How it works

  1. A holding in your taxable account is worth less than you paid.
  2. You sell it, realizing the loss for tax purposes.
  3. You immediately buy something similar, but not “substantially identical,” so your money stays invested.
  4. The realized loss lowers your taxes this year or in future years.

How the loss is used

  • Losses first cancel out capital gains (short-term against short-term and long-term against long-term first, then across).
  • Any net loss left over can reduce ordinary income by up to $3,000 a year ($1,500 if married filing separately).
  • Anything beyond that carries forward indefinitely to future years.
What a harvested loss is worth this yearInteractive
Gains cancelled$3,000
Taken off ordinary income$3,000
Carried forward$2,000
Federal tax saved this year$1,170

Losses first cancel out capital gains, then up to $3,000 a year can come off ordinary income, and anything left carries forward to future years with no expiry. Assumes the gains you offset are long-term. Watch the wash sale rule: don't buy the same or a substantially identical security within 30 days either side of the sale.

The wash sale rule

You can’t sell at a loss and buy the same thing right back. If you buy the same or a substantially identical security within 30 days before or after the sale, the loss is disallowed for now and added to the cost basis of the new shares. Traps that catch dividend investors:

TrapWhy it's a wash saleHow to avoid it
Automatic dividend reinvestmentA reinvested dividend is a purchase of the same fundTurn off reinvestment on that holding before selling
Buying it back in your IRAPurchases in your IRA count, and the loss can be lost for goodDon't buy the same fund in any account for 30 days
Your spouse buys itPurchases by your spouse countCoordinate across household accounts
Selling puts or buying callsOptions on the same security can trigger itAvoid options on it within the window

Swapping to stay invested

The usual approach is to swap into a fund that does a similar job but follows a different index, so it isn’t substantially identical. The IRS hasn’t published a precise definition, so many investors stick to funds that track clearly different indexes.

If you sellYou might buyWhy it's different
A high yield dividend ETFA different high yield ETF on a different indexDifferent selection rules and holdings
A dividend growth ETFA different dividend growth ETFDifferent eligibility and weighting
A REIT index fundA REIT fund tracking a different REIT indexDifferent index provider and holdings
A single stockA competitor, or a sector ETFA different company or a basket
A harvest in practice
You bought a dividend ETF for$50,000
It's now worth$42,000
Sell it and buy a similar dividend ETF on a different index$42,000 stays invested
Loss realized$8,000
Against $3,000 of gains plus $3,000 of income, 24% bracket and 15% gains rateabout $1,170 saved this year
Carried forward$2,000
Your new shares have a $42,000 cost basis, so the tax is partly deferred rather than erased: a later sale will have a bigger gain. The benefit is time, rate differences, and losses offsetting gains you'd have paid on anyway.

Keeping your dividend income

  • Watch the ex-dividend date. Sell after the old fund’s ex-date and buy the new one before its ex-date, and you won’t miss a payment.
  • Qualified status resets. The new fund’s dividends need their own holding period (more than 60 days around each ex-date) to be qualified. See How Dividends Are Taxed.
  • Swapping back. After 31 days you can return to the original fund if you prefer it, though that sale may realize a small gain or loss of its own.

Check your understanding

4 questions

  1. You realize a $10,000 loss and have $4,000 of capital gains this year. How much can reduce your ordinary income this year?

  2. You sell a fund at a loss and your dividends are set to reinvest automatically in the same fund. A dividend reinvests 10 days later. What happens?

  3. Which swap is generally considered safe from the wash sale rule?

  4. How long can unused capital losses be carried forward for an individual?

Finished reading?Mark it complete to fill in your progress bar. You can always undo it.

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Tax-Loss Harvesting for Dividend Investors, With Examples | Dividend Duel