For high-income earners, taxes are the biggest drag on wealth growth. But with strategic tools like ordinary loss harvesting, you can potentially keep more of your earnings and accelerate the compounding of your wealth over time. Let’s dive into how this works—and just how powerful it can be.
What Is Ordinary Loss Harvesting?
Ordinary loss harvesting involves using deductions from investment losses that are classified as “ordinary losses,” meaning they can offset ordinary income (like wages, salaries, and business income). This is particularly advantageous for high-income earners in top tax brackets, as these deductions directly reduce taxable income, creating immediate tax savings.
Ordinary losses are generally harder to achieve than capital losses (from stocks, bonds, or mutual funds), but they come with even greater tax advantages since they reduce income taxed at higher rates. However, strategies that realize ordinary losses are complex and require specialized knowledge, making them difficult to implement.
By offsetting income from these sources, ordinary loss harvesting doesn’t just provide immediate tax relief—it also frees up capital for reinvestment, fueling greater wealth compounding over time.
Why Ordinary Loss Harvesting Matters: A $500k Annual Deduction Example
Consider this: if you have the ability to harvest $500,000 in ordinary losses annually and apply it as a deduction, the impact on your wealth compounding can be profound. Here’s a breakdown using California’s top tax bracket (13.3%) and the federal top tax rate (37%).
- Ordinary Loss Deduction Amount: $500,000
- Combined Tax Savings (Federal + CA): Approx. 50% or $250,000 per year
If you invest that $250,000 tax savings at a 10% growth rate over 30 years, the compounding effect is substantial compared to a scenario where these losses are not harvested.
Ordinary Loss Harvesting and Roth Conversions
Ordinary loss harvesting doesn’t just improve compounding directly—it also unlocks other powerful tax strategies. We’ve talked about Roth conversions, where you convert a traditional IRA to a Roth IRA, as a common strategy for high-income earners aiming for tax-free growth in retirement. With Roth conversions:
- How it works: You convert pre-tax retirement assets (traditional IRAs) to Roth IRAs, pay taxes on the converted amount, and then benefit from tax-free growth in the Roth account.
- Benefit: All future growth in the Roth IRA is tax-free, and distributions in retirement are also tax-free.
When you pair Roth conversions with ordinary loss harvesting, you can effectively shield your conversion from income taxes. For instance, if you plan a Roth conversion of $500,000, the ordinary losses can offset the tax on that conversion, saving hundreds of thousands in taxes and leaving more to grow tax-free in your Roth account.
Conclusion: Supercharging Wealth with Ordinary Loss Harvesting
Ordinary loss harvesting isn’t just about saving on taxes—it’s a tool that can radically accelerate your wealth growth and open doors to even greater tax optimization. By consistently reducing taxable income, reinvesting tax savings, and strategically pairing with Roth conversions, you’re harnessing the power of compounding at an elite level.