Summary
In tax loss harvesting, deciding which tax lots to sell is a critical but often overlooked step. Most portfolios hold multiple lots of the same asset, each with different purchase dates, cost bases, and tax characteristics.
A disciplined, lot-level selection process evaluates each tax lot independently to minimise total tax impact-both today and in the future-while preserving portfolio integrity.
Why Lot Selection Matters in Tax Loss Harvesting
Selling the wrong tax lot can reduce realised losses, trigger unnecessary gains, and increase future tax liabilities. A systematic approach ensures tax loss harvesting decisions are consistent and defensible.
What Is Lot-Level Selection?
Lot-level selection is the process of choosing specific tax lots to sell based on unrealised gains or losses, holding period, and cost basis rather than relying on default accounting methods.
Tax Lot Fundamentals
- Purchase date
- Quantity
- Cost basis
- Unrealised gain or loss
- Holding period
Core Principle: Minimise Tax, Not Turnover
Lot-level selection prioritises harvesting losses, avoiding gains where possible, and preferring long-term gains when sales are unavoidable.
Lot-Level Ranking Logic (Conceptual)
- Largest unrealised losses
- Smaller unrealised losses
- Minimal unrealised gains
- Larger unrealised gains
Short-Term vs Long-Term Considerations
Holding period matters. In many jurisdictions, short-term gains are taxed at higher rates, making holding-period-aware selection essential.
Worked Example (Illustrative, Real-World)
An adviser holds multiple tax lots of Vanguard Total Stock Market ETF (VTI) purchased at different times:
- 100 shares bought on 15 Jun 2023 at $235 (current price: $210 Ui unrealised loss)
- 100 shares bought on 10 Feb 2022 at $190 (current price: $210 Ui unrealised gain)
To implement tax loss harvesting, the system evaluates lots at the individual level and selects the loss-making lot for sale, avoiding the gain-bearing lot.
The loss is realised by selling the June 2023 lot, and proceeds are reinvested into a highly correlated replacement ETF (e.g. iShares Core S&P Total U.S. Stock Market ETF (ITOT)) to maintain U.S. equity exposure. The client realises the tax loss while remaining effectively invested.
Interaction With Replacement Assets
After selling a specific lot, proceeds are reinvested into a highly correlated replacement asset to preserve portfolio exposure.
Governance and Documentation
Defensible tax loss harvesting requires documenting lot-level rules, lots evaluated, lots selected, and the rationale for decisions.
Frequently Asked Questions
Is lot-level selection required for tax loss harvesting?
While not mandatory, it materially improves precision and defensibility compared to default methods.
Can lot-level selection be automated?
Yes. Because it is rules-based, it can be implemented systematically and reviewed consistently.
Final Thoughts
Lot-level selection is a foundational component of disciplined tax loss harvesting, supporting improved after-tax outcomes without compromising portfolio integrity.
