Tax Loss Harvesting with Fidelity: A Step by Step Guide

DDQWhen the stock market gives you lemons, make lemonade.

In December of 2018, the markets have been delivering lemons by the truckload. We’ve seen a drop of about 7% in one week and most major indices for the US stock market are at or near bear market territory.

While I don’t enjoy seeing six-figure sums disappear from my portfolio, I try to do the best I can with what I have. When I have an abundance of lots with losses, I squeeze those lemons with a technique known as Tax Loss Harvesting (TLH).

I’ve previously shared a guide to TLH with Vanguard, showing screenshots every step of the way. In that post, I also go into more detail regarding the rationale, benefits, and ways to goof it up, so I encourage you to review that first post if you have questions about TLH and the reasoning behind it.

 

Tax Loss Harvesting with Vanguard: A Step by Step Guide

 

Currently, I only have a taxable brokerage account (the only account type that can benefit from TLH) with Vanguard. However, the couple I helped when they were ready to break up with their advisor uses Fidelity. I found some TLH opportunities for them, and I’m happy to share them with you.

 

Tax Loss Harvesting with Fidelity: A Step by Step Guide

 

 

Tax Loss Harvesting Summary

 

TLH is the process of selling shares of an asset at a loss. It is typically paired with the simultaneous or subsequent purchase of a similar but non-identical asset.

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The process only works in a taxable account, a.k.a. brokerage account. Making a similar trade in a 401(k), IRA, or other tax-advantaged retirement account will not give you a tax benefit, but you can create an inadvertent wash sale in those accounts, reducing the benefit of your TLH efforts in the brokerage account. More on wash sales later.

As an index fund investor, my experience is in exchanging one fund for another. You can harvest losses with individual stocks, but the difficulty is finding another stock that you can expect to perform similarly. The point of TLH is that you’re taking a paper loss without actually altering your asset allocation significantly.

You can also tax loss harvest with ETFs. You may miss out on time in the market if you’re waiting for the proceeds of the sale to hit your settlement fund before you can use it to buy a TLH partner. This may be inconsequential or even beneficial if the market continues to drop while you’re waiting.

 

Why Tax Loss Harvest?

 

When you take a paper loss, those losses will first be used to offset any capital gains you may have incurred that year. If you’re an index fund investor buying and holding, there’s a good chance you won’t have any capital gains to offset in most years.

Once any gains have been canceled out, your tax losses will be used to deduct up to $3,000 per year of ordinary income.

This is key. A high-income professional may have a marginal income tax rate (federal, state, and local) of 35% to 50%. That $3,000 deduction can be worth $1,000 to $1,500 per year.

Moreover, additional losses can be carried over to future years. As I showed in the Vanguard TLH post, in 2016, a year in which the S&P 500 experience a double-digit gain, I was able to harvest over $50,000 in tax losses. That’s 16+ years worth of $3,000 deductions. If I were to remain in the upper income tax brackets, the value of those TLH efforts would exceed $20,000.

Now, it is true that when you tax loss harvest, you are lowering your cost basis in the funds you own. That could set you up to recapture some of the taxes in the form of paying more capital gains taxes later.

However, it’s well worth it to save on ordinary income taxes now (at 35% to 50% rates) to possibly pay capital gains taxes later at 0% to 35% later. Nearly everyone will pay a lower capital gains rate later than income tax rate now. At worst, you’re deferring the tax.

Additionally, there are ways to avoid capital gains taxes entirely. In retirement, you may be in the 0% capital gains bracket with a taxable income up to $78,750 in 2019. You may be able to take advantage of a free increase in your cost basis in that 0% bracket by doing some tax gain harvesting in that situation.

If you have charitable aspirations, you can donate funds with the lowest cost basis (and most potential gains) to charity. I do this by donating to and from a donor advised fund.

Finally, if you die with assets in a taxable brokerage account, the cost basis is reset to the current value when inherited. Those potential capital gains taxes disappear.

 

Avoid a Wash Sale

 

If you sell an asset for a loss, some or all of that loss will be ineligible to be reported as a loss if you have a purchase of the same or a “substantially identical” asset 30 days before or after your TLH sale.


For example, in a previous example of TLH timed with the Brexit vote, I exchanged VFWAX to VTMGX and VTSAX to VFIAX on June 27, 2016.

I could have created a wash sale if I had:

  • Purchased VTSAX or VFWAX between June 27, 2016 and  July 28, 2016.
  • Held onto shares of VTSAX or VFWAX purchased between May 27 and June 26, 2016. If I had purchased either VTSAX or VFWAX in that timeframe, as long as I sold them with the other losing lots on June 27, it would not have been an issue.

 

The purchase of substantially identical shares during that 61-day window would also constitute a wash sale. I would consider the higher cost Investor shares of these Admiral funds to be substantially identical. The same goes for the ETF versions of the funds. They follow the same index and hold the same stocks in the same proportions.

Prevailing opinion from quality sources including Bogleheads is that funds tracking different indices are not substantially identical even if there is significant overlap.

In today’s examples, I’ll demonstrate exchanging Fidelity’s Total Market Index Fund (FSKAX) for their No-Fee ZERO Total Stock Market Fund (FZROX). The former tracks the Dow Jones U.S. Total Stock Market Index while the latter tracks a new proprietary index from Fidelity.

Similarly, we’ll be selling Fidelity’s Total International Index Fund (FTIHX) for their No-Fee ZERO International Index Fund (FZILX).

The best way to avoid making an accidental wash sale is to turn off automated investments and automatic reinvestment of dividends. It’s also good practice to avoid holding substantially identical funds in any IRAs that your or your spouse periodically invest (or reinvest dividends) in.

401(k), 457(b), 403(b), HSA and similar accounts fall under the “gray area” category in my mind (and that of Michael Piper, the Oblivious Investor). I personally avoid holding substantially identical assets to that which I hold in taxable in such accounts to be squeaky clean when I TLH.

 

Turn Off Automated Dividend Reinvestment

 

The first thing I did was to turn off automated dividend reinvestment. While I don’t expect another dividend to be paid out until March, it’s best practice to manually reinvest dividends to whichever asset class is below your chosen asset allocation based on your Investor Policy Statement. In the future, there may be TLH opportunities near an ex-dividend date.

I couldn’t clearly see how to do this, so I used the search box in the upper right hand corner. That led me to this page, which had the big blue button I needed.

 

 

 

If your Dividends and Capital Gains say “Deposit to Core Account,” you’re good to go. If they say “Reinvest in Security” or something different, you’ll to click on “Update.”

 

 

That will lead you to the following screen. I’ve chosen to deposit to Core Account rather than direct them to a single mutual fund. I was able to apply to all mutual funds in the account with a check in the box.

 

 

 

TLH Step 1: Identify Losing Lots

 

First, click on the “Positions” tab to see what you own.

 

 

To see the individual lots, first click on the fund name and then on “Purchase History / Lots.”

 

 

“Today’s Gain/Loss” is not relevant to what we’re doing today. We’re interested in the Total Gain/Loss of each individual lot displayed. In this case, only the four most recent lots purchased have a loss (displayed in red). We’re in the green for any lots purchased in 2016. We only want to sell the reds.

Fidelity will be asking how many shares I want to sell. To add up 325.331 + 474.69 + 7080.462 + 264.480, I copied the data via mouse and pasted into a Google Sheet.

 

 

Selecting the four values from the Quantity column and selecting the “SUM” function, I see that I want to sell 8,144.922 shares of FTIHX. I could have used a calculator, but this way is honestly easier and less error-prone, particularly if you are selling dozens of lots at once as someone who invests with each paycheck might be doing.

 

 

TLH Step 2: Exchange One Fund for Another

 

I’ve decided to exchange shares of FTIHX into another international fund Fidelity offers, the No-Fee ZERO International Index Fund (FZILX). While these will track similarly, they are not identical, a fact that is demonstrated with a quick comparison of their recent history. Most of the difference comes from the dividend paid out on 12/7 from FTIHX but even before that, there were slight differences.

 

 

I click the green “Trade” button.

 

 

In the popup, I select “Specific Shares.” You can also select the default cost basis elsewhere, but regardless of what selection you have for your cost basis, the “Specific Shares” option will be there for you to choose. The Vanguard equivalent is “Specific ID,” which must be specified beforehand to sell specific lots.

 

 

 

In order to exchange one fund for another without sitting out of the market for any length of time, I choose “Sell a Mutual Fund and use the proceeds to buy another mutual fund.

 

 

Next, I enter the new fund I’m buying and the number of shares in the losing lots that we calculated earlier.

 

 

I’ll be asked how I want to see the lots displayed. To make things easier, I’ll opt to arrange by highest cost. The highest cost lots are most likely to have tax losses.

 

 

 

 

After that, I choose to sell only the losing lots. Just as they were above, the numbers will be in red. Next, I verify that the information is correct. Fidelity doesn’t want to see frequent trading, and selling a fund purchased within 30 days is considered a “roundtrip transaction.” More than four of these in the same account will put a hold on your ability to trade for awhile. More information is available in Fidelity’s Excessive Trading Policy.

Turning off the automatic dividend reinvestment will limit the number of roundtrip transactions possible, another reason to make that change, which I’ve done.

 

 

 

After checking the box and clicking on “Place Order,” we’re done!

 

 

A Simple Fidelity TLH

 

That first one got a bit complex due to the mix of lots with both gains and losses.

This brokerage account also holds a fund (FSKAX) with only losses, no gains. In this next example, we’ll simply sell the fund in its entirety since all four lots have capital losses.

Like above, we’ll make a direct exchange. This time, we’re trading Fidelity’s Total Market Index Fund (FSKAX) for their No-Fee ZERO Total Stock Market Fund (FZROX). The two will be expected to correlate extremely closely, but they mirror different indices and are therefore not considered by most to be substantially identical.

 

 

When expanding by clicking on “Purchase History / Lots,” I see that all our lots purchased have losses. Again, we don’t have to worry about selling specific lots. From the dropdown box, I choose “Sell All Shares and use proceeds to buy another.”

 

 

In the box that’s partially hidden above, I enter the name of the fund I’ll be buying, FZROX.

 

 

A click on “Preview Order” and I get an opportunity to look things over. Once again, it’s a “roundtrip transaction.” Some of the proceeds from a Required Minimum Distribution were invested here and a dividend was reinvested within the last 30 days. No worries. I can do this; I just can’t do it too often.

 

 

We’re ready to click “Place Order” to harvest those tax losses.

 

 

That’s all there is to it!

 

The Results of This Tax Loss Harvesting

 

In addition to the two TLH events recorded above, I also sold some losing lots of a third fund, one of the active funds that we were stuck with (but have now decided to sell without tax consequence, using some of our newly-acquired paper losses to offset the smaller gains).

As you can see in some of the screenshots above, these transactions were entered on Sunday, 12/23/2018. As these are mutual funds, the orders were executed at the next closing bell.

It just so happens that 12/24/2018 was a very, very bad day for the stock market, with the largest drops in either percentage or absolute value on a Christmas Eve day. In other words, it was a good day to tax loss harvest.

A couple of days later, I clicked on “Closed Positions” to see the results of my efforts.

 

 

Altogether, we had $22,531 in paper losses in three transactions, with $4,069 in short-term losses and $18,463 in long-term losses.

Both short-term and long-term losses can be used to offset ordinary income or either type of capital loss. Short-term first offset short-term gains and long-term losses first offset long-term gains, but short-term losses can offset long-term gains, and vice-versa.

 

It’s Your Turn to Tax Loss Harvest

 

While it may look complicated, it’s only because I captured nearly every screen shot in the process. In practice, once you understand the concept and can navigate the website, it shouldn’t take more than a few minutes to properly execute a tax loss harvesting transaction.

By harvesting about $20,000 in losses in these two transactions, this couple’s ordinary income will be reduced by $3,000 this year and for up to five or six more years.

Alternatively, they could use some of the remaining carryover losses to sell out of the final two actively managed funds remaining in their taxable account. We did our best when simplifying this portfolio from 28 funds, but to avoid paying capital gains taxes, we couldn’t quite whittle it down to a three fund portfolio.

Now, with only about $10,000 in gains in those tax-inefficient funds, they can be sold without having to pay the capital gains taxes on the sale. That would eat up a few years’ worth of potential ordinary income deductions, but I’m not too concerned.

I have a feeling we may be harvesting additional losses in the future.

 


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25 comments

  • Scott Frey

    Thanks for the tutorial PoF! Easy step by step guide on how to TLH. One question I do have is regarding future purchases. I understand the part about turning off reinvestment of dividends, but what about future purchases? When we are making automatic monthly investments, do you recommend we continue to buy the new fund (that we bought to TLH) or the previously owned fund? Thanks for your insight. Merry Christmas to you and your family!

    Scott

    • It’s up to you, but your two options are to wait 31 days and buy into what you sold or buy into the new fund at any time. Note that if the new fund is down 31 days later, you can TLH back into your original position.

      Cheers!
      -PoF

      • Rashmi Benda

        Thx for the step by step guide. So, does it apply to the same account or I have to go through the rest of my accounts— 401K and my HSA to make sure I am not contributing to the same account the next day? there is automatic contribution to these every 2 weeks from my paycheck.

        • While an IRA purchase in the 61-day window encompassing a month before and after can definitely create a wash sale, other accounts are gray areas.

          As stated, I like to avoid gray areas when I easily can, so I don’t invest in like funds elsewhere compared to what I own in taxable.

          Best,
          -PoF

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  • Alexander

    Great article! Had a few general questions though.

    Fidelity’s default is average cost basis with a disposal method set to FIFO. I understand that the former has to be switched to Specific ID but I’m a little perplexed by the number of disposal methods available. Disposal methods available include FIFO, LIFO, High Cost, High Cost – Long Term, High Cost – Short Term, Low Cost, Low Cost – Long Term, Low Cost – Short Term, Tax Sensitive, Tax Sensitive – Short Term. Which option did you select as default disposal method?

    Also, if I’m holding FTIHX in my Roth IRA as well, is it wise to convert my holdings to FZILX as well in order to combat any risk of a wash sale?

    • I took screen shots of this process and then I realized it doesn’t matter. I found it odd there was no option for “specific shares” and that’s because that option will always be offered up when you go to sell / exchange, regardless of what the default setting is.

      I believe I went with “High Cost — Short Term” as the default as those would be the shares most likely harvested for losses, but I ended up having the opportunity to select specific shares anyway.

      Best,
      -PoF

  • Seth

    Very well timed article and very informative. Thanks!

    We started a taxable account for my daughter this past year with gift money. Invested it in VTSAX for the long run. Sad to see it take a hit, but maybe a good opportunity to teach tax loss harvesting. My question is can she tax loss Harvest without any income or capital gains by carrying the losses forward? For how long can the losses from this year be carried? Is the mechanism the same?

    Happy Holidays!

    • Until she’s got earned income to offset in a decent tax bracket, I don’t know that there would be a good reason to TLH. I would consult a CPA, but my guess is that the future benefit will be small, assuming when she does first start earning an income, it won’t be in the six-figures immediately.

      On the other hand, there’s nothing to lose by doing it, and it might be a good learning process. Just be comfortable hanging on to the new fund indefinitely.

      Cheers!
      -PoF

  • “Note that if the new fund is down 31 days later, you can TLH back into your original position.”

    I was actually going to ask you if this would work, and you have answered it here. 🙂

    In November I TLH from one International Fund to another (tracking separate indices of course). Its been about 45 days since the first move and with the latest tanking of the market, the new fund has some big losses too. So I will sell this week and move back to the original fund.

    I have some old, expensive mutual funds that I have had forever with decent gains, so these harvested losses will help me get out of the funds without paying any taxes.

    Thanks for sharing this info again!

    Happy Holidays!

    • You know what to do!

      I will likely do something similar with this large realized loss, ditching the two remaining actively managed funds in this portfolio and offsetting the capital gains from those sales. There will still be carryover losses after those transactions are complete, assuming we don’t see a quick rebound.

      Cheers!
      -PoF

  • Caligas

    What if I have one ETF with $3k In losses, another with $10k in losses and a third with $10k in gains. I’ve made no trades so far in the year.

    Do I JUST harvest the $3k in losses OR do also sell the other two ETFs so that I can eliminate the capital gains on the ETF that is up $10k?

    • Unless there is a reason you no longer want to own the fund with gains, keep it.

      You can take $13k in paper losses and carry most of that over to future years. Buy something similar to avoid locking in true losses.

      Cheers!
      -PoF

  • Gasem

    Just TLH about 20k. This time used the 31 day method since I want to convert 2 funds with losses in both back into one of the 2 funds going forward. My exposure is a month of not being invested if the market explodes. But the rest of my portfolio remains invested so that’s a small risk. My gain is guaranteed TLH and I convert the funds to my desired AA with no other tax consequence. Homey likes that. I consider TLH a separate non correlated asset class

    Great article

  • Larry Ragman

    POF, I refer to your classic Vanguard TLH post whenever I think a TLH situation is developing. I don’t use Fidelity’s funds but it is good to see this post lay out the advantages to another community.

    Just one comment on your approach as an alternative for casual readers. It is not necessarily required to avoid dividend reinvestment and auto investments to do a TLH transaction. Yes, I agree your approach works best who wants to be set up to TLH anytime an opportunity arises. But I only occasionally TLH, and I leave my dividend and auto reinvestments on in order to simplify my long term investments.

    So instead, if the market drops and I want to TLH I just make sure I sell any shares purchased within 30 days in the fund I am harvesting, including auto investments. And of course, I can’t buy any new shares in that fund for 30 days either, but that is controllable. That is, do not TLH within 30 days of a quarterly dividend being posted (end M, J,S, and D), and suspend auto investments in the harvested fund for 30 days.

    I acknowledge that I might miss opportunities, but I have been lucky in my timing. Just managed to hit a great TLH opportunity on 12/24.

    • Thanks for the comments, Larry!

      Your approach is perfectly sensible, and I would add that even if you do have an automated dividend reinvestment following a TLH event, as long as the dollar value is substantially less than the loss you took, the partial wash sale just means your loss will be just a little bit smaller than it would have been otherwise.

      Cheers!
      -PoF

  • Ryan

    Such a great post, especially for those of us who use Fidelity. I’m in that exact situation where I’m looking to sell FSKAX for FZROZ and FTIHX for FZILZ.
    My one question that I can’t seem to understand though is I unfortunately didn’t turn off my automatic dividend reinvestment in time and my dividends were reinvested on 12/7. Do I need to wait until 1/8 to to buy FZROZ and FZILZ or can I sell and buy right now? I am planning on selling all shares of both because all lots are at a loss right now.

    • You can do it now as long as you sell the lots that resulted from the reinvested dividend. If you sell any lots purchased in the last 30 days, they won’t be there as “replacement lots” to count as a wash sale.

      Cheers!
      -PoF

  • Zac

    This is still a topic I have a hard time wrapping my brain around but you did an excellent job laying it out. The vast majority of my investments are in tax-sheltered accounts so it doesn’t apply to me so much (yet) but I do think that as an investor this is crucial information to get down pat.

  • Cam Elward

    Thanks, Physician on fire! I feel much more capable of DIY TLH’ing now.

    Simple question, my apologies if you’ve already answered in the above posts. In the example provided, how did you avoid a wash sale? I mean, it seems to me that you sold and bought a similar fund on the same day. To execute TLH properly, wouldn’t you have to make the sale, and the log back into your fidelity account 30 days later to purchase a comparable fund? Again, my apologies if this question is rudimentary.

  • Ryan

    Thank you so much for your help. I definitely need to study up more on the wash sale rules as I don’t feel like I have a total handle on how they work.
    I did end up doing the exchange of FSKAX for FZROZ and FTIHX for FZILZ. If I’m understanding correctly, I can now buy shares of FZROZ and FZILZ as early as, for example, tomorrow and not have any issues with a wash sale.
    The problem would be if I bought new shares of the old fund that I traded out of, right?

    Thanks for explaining all of this.

  • FYI: I think Fidelity’s consolidation of some of its index fund classes messed up basis information, thereby making TLHing near impossible for those older share lots. Here’s my transaction history in the Fidelity S&P 500 Index fund, which until November 2, 2018 was FUSEX and is now FXAIX. All the lots prior to Nov. 2 have the exact same per share cost same basis.

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