For high-income Californians, the tax system makes managing capital gains a critical part of wealth strategy. California taxes all capital gains, long or short-term at ordinary income rates up to 13.3%, on top of federal long-term capital gains rates of up to 20% plus the 3.8% NIIT. Combined, that's a 37%–38% hit on long-term gains or ~54% hit on short-term gains.
One of the most effective ways to combat this burden is targeted tax-loss harvesting - a deliberate, hands-on approach to selling underperforming investments to capture losses that directly offset taxable gains.
1. What Is Targeted Tax-Loss Harvesting?
Unlike automated strategies, targeted harvesting involves cherry-picking specific securities in your portfolio that are underwater and selling them to realize the loss.
The losses are then used to:
- Offset realized capital gains (short or long-term).
- Offset up to $3,000 of ordinary income per year if losses exceed gains.
- Carry forward any unused losses indefinitely for future use.
This manual approach works best for investors who:
- Have concentrated positions.
- Regularly realize large gains (e.g., selling appreciated stock)
- Live in high-tax states like California, where every dollar saved has an outsized impact.
2. Why It Matters More in California
Capital Gains = Ordinary Income
California doesn't differentiate between long and short-term gains. If you sell appreciated stock, it is taxed as high as 13.3%. That means harvested losses shield income taxed at the top bracket, not just at reduced rates.
Layered Federal + State Rates
Offsetting gains at a combined 37–38% rate for long term gains is far more valuable than in a no-income-tax state like Texas or Florida.
Example:
- You sell shares with a $100,000 long term gain.
- In California, that gain could generate a $37,000+ tax bill.
- If you harvest $100,000 in losses, you eliminate that liability entirely.
3. Practical Steps for Targeted Harvesting
a) Identify Candidates
- Look for stocks, ETFs in a taxable account trading below your purchase price.
- Focus on positions unlikely to rebound quickly or those you no longer want to hold long-term.
b) Mind the Wash-Sale Rule
You cannot buy the same or "substantially identical" security within 30 days before or after the sale.
Workarounds:
- Swap to a similar (but not identical) ETF or stock to maintain market exposure.
- Use the 31-day waiting period to rebalance into a slightly different asset class.
c) Time It Strategically
- Don't wait until December. Harvesting throughout the year, especially during market pullbacks gives more flexibility.
- Pair harvests with large capital events (e.g. sell concentrated position)
d) Keep Records Organized
- Track the cost basis, sale proceeds, and date of each harvested position.
- Ensure proper reporting on federal and California returns.
4. Targeted Use Cases for Californians
RSU Sales
Many California tech employees realize large taxable gains when selling employer stock. Targeted harvesting can offset these concentrated positions.
Portfolio Rebalancing
If rebalancing creates realized gains, harvesting losses elsewhere in the portfolio can neutralize the tax hit.
5. Case Study: The Power of Harvesting in California
Here's a simplified example showing how targeted tax-loss harvesting can create significant savings:
| Scenario | Without Harvesting | With $200,000 Harvested Loss |
|---|---|---|
| Capital Gains Realized | $250,000 | $250,000 |
| Losses Applied | $0 | -$200,000 |
| Net Taxable Gain | $250,000 | $50,000 |
| Estimated Combined Tax (37%) | ~$92,500 | ~$18,500 |
| Total Tax Savings | $0 | ~$74,000 |
By harvesting $200,000 in losses, the investor reduced their taxable gain from $250K to just $50K, saving roughly $74,000 in combined federal + California taxes.
6. Limitations and Risks
- Market Risk: If you sell and sit out 30+ days, you may miss a rebound.
- Concentration Risk: Replacing with "similar but not identical" securities is key to staying invested.
- Deductions Are Limited: Only $3,000 of losses can offset ordinary income per year. The rest carries forward.
Bottom Line
For high-income Californians, targeted tax-loss harvesting is one of the most valuable tax tools available. By carefully selecting underperforming positions and timing harvests to align with major capital events, investors can shield gains that would otherwise face some of the nation's harshest combined tax rates.
It's not about chasing losses, it's about using volatility and underperformance as an asset, turning red ink into meaningful tax savings.