Wealthfront Tax Loss Harvesting: How It Works and Key Considerations

Tax-loss harvesting helps investors reduce taxable income by selling investments at a loss to offset gains. Wealthfront, an automated investment platform, offers this feature as part of its robo-advisory service, aiming to improve after-tax returns without requiring manual intervention.

While the concept is appealing, investors should consider tax rules, asset selection, and potential limitations that could affect its effectiveness. Understanding these factors can help determine whether Wealthfront’s tax-loss harvesting aligns with their financial goals.

How Gains Are Offset

When an investment is sold for less than its purchase price, the resulting capital loss can offset taxable gains. The IRS allows investors to apply losses against gains of the same type—short-term losses offset short-term gains, while long-term losses apply to long-term gains. Short-term gains, from assets held for one year or less, are taxed at ordinary income rates, which can be as high as 37% in 2024. Long-term gains, from assets held for more than a year, are taxed at lower rates, ranging from 0% to 20% depending on income.

If total capital losses exceed capital gains in a given tax year, up to $3,000 of the remaining loss can be deducted against ordinary income ($1,500 for married individuals filing separately). Any unused losses beyond this limit can be carried forward indefinitely to offset future gains. This carryforward provision can be useful in years when an investor has minimal gains but expects higher taxable income later.

Wealthfront’s automated system scans for opportunities to realize losses while maintaining market exposure. By selling a depreciated asset and replacing it with a similar, but not identical, security, the platform keeps the portfolio aligned with the investor’s risk profile. This process generates tax savings without requiring the investor to track losses or execute trades manually.

Which Assets May Be Involved

Wealthfront’s tax-loss harvesting primarily involves exchange-traded funds (ETFs) that track broad market indices, sector-specific benchmarks, or factor-based strategies. These ETFs offer liquidity, low expense ratios, and diversification, making them well-suited for automated tax strategies. The platform selects pairs of similar ETFs that can be swapped when one experiences a loss, ensuring continued market exposure while capturing tax benefits.

For investors using Wealthfront’s Stock-Level Tax-Loss Harvesting (SLTH) feature, individual stocks within an index may also be included. This approach applies the same concept to individual equities, allowing for more precise tax management. By selling underperforming stocks and replacing them with highly correlated alternatives, the strategy seeks to maximize realized losses while maintaining portfolio composition.

Municipal bonds, corporate bonds, and other fixed-income securities are generally excluded due to their different tax treatment. Interest income from these assets is taxed differently than capital gains, limiting the effectiveness of harvesting losses. Additionally, bond ETFs tend to be less volatile than equity ETFs, reducing the frequency of loss-harvesting opportunities.

Wash Sale Rule Considerations

The IRS wash sale rule prevents taxpayers from claiming a loss on a security if they purchase a “substantially identical” asset within 30 days before or after the sale. This rule is meant to stop investors from selling at a loss purely for tax benefits while maintaining the same economic exposure. If a wash sale occurs, the disallowed loss is added to the cost basis of the replacement security, deferring the tax benefit until a later sale.

Wealthfront’s algorithm is designed to avoid wash sales by selecting replacement ETFs that track similar, but not identical, indices. For example, if the platform sells an ETF tracking the S&P 500 at a loss, it may replace it with an ETF tracking the Russell 1000. While both funds provide large-cap exposure, they are not considered substantially identical under IRS guidelines. This approach allows the portfolio to remain invested while ensuring that losses remain deductible.

Investor activity outside of Wealthfront can still trigger wash sales. If an investor owns the same ETF in a different brokerage account or purchases it in an IRA, the wash sale rule applies across all accounts. Even an automatic dividend reinvestment in another account could disqualify a loss. Wealthfront does not have visibility into external holdings, so investors should monitor their transactions to avoid unintentionally negating tax benefits.

Realized vs. Unrealized Loss Positions

Losses in an investment portfolio can exist in two forms: realized and unrealized. A loss remains unrealized as long as the asset is still held—its market value has declined below its purchase price, but no sale has occurred. These losses affect portfolio performance but have no immediate tax implications. Only when an asset is sold at a lower price than its original cost does the loss become realized, allowing it to offset taxable gains or reduce income under IRS rules.

Wealthfront’s tax-loss harvesting converts unrealized losses into realized ones without significantly altering the portfolio’s risk exposure. The platform continuously monitors price movements to determine when a security has dropped enough to justify selling it. Minor fluctuations might not warrant a sale if the tax benefit is minimal, while sharper declines provide more meaningful opportunities. This systematic approach contrasts with a passive strategy where unrealized losses might persist indefinitely without delivering any tax advantage.