AI Tax-Loss Harvesting and Rebalancing

Harvesting engines at firms such as Wealthfront and Betterment, and direct-indexing platforms from Parametric, Aperio (BlackRock), Schwab and Fidelity, follow the same basic logic. Most of it is rules and numerical optimization rather than machine learning. Each day the engine looks at every tax lot, meaning each separate purchase, and compares its current price with its cost basis. A lot becomes a candidate when its loss passes thresholds that account for trading costs, the size of the tax benefit, and whether the loss is short-term or long-term. The main constraint is the wash sale rule in Internal Revenue Code Section 1091. If you buy a substantially identical security within 30 days before or after a loss sale, the loss is disallowed. The rule covers purchases in other accounts, including a spouse's accounts and IRAs. When the repurchase happens in an IRA, IRS Revenue Ruling 2008-5 means the loss is lost permanently instead of being added to the basis of the new shares. Automatic dividend reinvestment can also trigger a wash sale without anyone noticing. Direct indexing gives the engine more room because it holds individual stocks. Some stocks can show losses even in a year when the index rises. The trade-off is loss harvesting decay: as markets rise over the years, fewer lots sit below cost, and the portfolio fills up with appreciated shares. A common misconception is that harvesting erases taxes. Selling at a loss and buying a replacement lowers the portfolio's cost basis, so more gain is taxed when the replacement is sold later. The benefit is deferral, plus converting rates in some cases. It becomes permanent mainly through a step-up in basis at death or by donating appreciated shares.