The Basics of Tax Loss Harvesting

You sell a losing position, book the loss, and buy a similar investment to keep your allocation intact. The realized loss offsets gains taken elsewhere in the year. Losses beyond your gains can offset up to $3,000 of ordinary income annually, with unlimited carryforward.

The IRS tracks this through Form 8949 and Schedule D. California uses Schedule D (540) on your state return. Because California conforms to the federal wash sale rule, any loss disallowed federally is also disallowed on your California return.

California’s Tax Rate Makes Every Loss Worth More

Here’s what a top-bracket LA investor faces on capital gains:

• Short-term gains: 37% federal + 3.8% NIIT + 13.3% California = 54.1% combined
• Long-term gains: 20% federal + 3.8% NIIT + 13.3% California = 37.1% combined

That long-term rate is the big story. In most states, long-term gains get favorable treatment at both the federal and state level. California says no. A long-term gain of $100,000 costs you $37,100 in taxes in Los Angeles. In Austin, where Texas has no income tax, that same gain costs $23,800. The $13,300 difference is entirely the California tax.

This means harvesting long-term losses is substantially more valuable for LA investors than for investors in most other states. Nationally, advisors focus on harvesting short-term losses because the federal rate difference between short-term and long-term is large. In California, both types of losses save you 13.3% at the state level, so the distinction matters less.

The Wash Sale Rule and California Conformity

California conforms to the federal wash sale rule under IRC Section 1091. If you sell a security at a loss and buy a substantially identical one within 30 days before or after the sale, the loss is disallowed for both federal and California purposes.

The practical approach: swap into a similar but not identical fund. Sell your Vanguard Total Stock Market fund (VTI) at a loss and buy the Schwab U.S. Broad Market ETF (SCHB). Same exposure, different fund. Wait 31 days if you want to switch back.

One California-specific wrinkle: if you’re considering a move out of state, harvesting losses before you leave California is generally smarter than waiting. Once you’re a non-resident, California only taxes your California-source income, and capital gains from selling securities are typically sourced to your state of residence. Harvest the loss while you’re still here and it reduces your California tax liability. Wait until after you move, and the California benefit disappears.

Timing: Year-Round vs. Year-End

Tax loss harvesting isn’t a December tradition — it’s a year-round practice. The best opportunities appear after market drops, and those don’t follow the calendar. An LA investor who harvested losses during the sell-off in early 2022 locked in far larger savings than someone who waited until December, by which point many positions had partially recovered.

California’s estimated tax payment schedule adds another layer. The state’s quarterly payment dates align with federal ones, but California’s penalties for underpayment are calculated differently. If you harvest a large loss in Q4, it changes your projected annual tax liability, and you may be able to reduce your January 15 estimated payment accordingly. Miss this adjustment and you’ll have overpaid, giving Sacramento an interest-free float on your money until you file your return.

Entertainment Industry and Concentrated Stock

LA’s entertainment professionals face a specific version of this problem. Writers, producers, and executives who receive stock compensation from media companies — Disney, Netflix, Warner Bros. Discovery — often hold concentrated positions that can swing wildly in value.

When one of these positions drops below your cost basis, that’s a harvesting opportunity. Sell, book the loss, and diversify into a broader media ETF or the full market. You get the tax benefit and reduce your concentration risk at the same time. For someone sitting on a $500,000 unrealized loss in a single media stock, the combined federal and California tax savings from harvesting that loss could exceed $185,000.

Production and entertainment professionals with RSUs or stock options should review their positions quarterly with a tax advisor. The interaction between equity compensation rules (Section 83(b) elections, ISO vs. NSO treatment) and loss harvesting timing creates opportunities that most generic robo-advisors miss entirely.