Please help me understand tax loss harvesting

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timmarkell
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Please help me understand tax loss harvesting

Post by timmarkell »

On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
toddthebod
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Re: Please help me understand tax loss harvesting

Post by toddthebod »

timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
Backtests without cash flows are meaningless. Returns without dividends are lies.
sailaway
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Re: Please help me understand tax loss harvesting

Post by sailaway »

You reinvest the money into something similar. If you sell an SP500 fund, you can purchase a total market fund, for example. This way, your money isn't out of the market and you aren't trying to guess at when to get back in.

You aren't necessarily getting a benefit on the capital gains, as you are repurchasing with a lower cost basis. The main benefit is from the max $3k offset of ordinary income.

Personally, I can't get as excited about it as some other folks do. Perhaps just because we are in a lower tax bracket?
Topic Author
timmarkell
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Re: Please help me understand tax loss harvesting

Post by timmarkell »

toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
How is switching from Vanguard's Total Market fund to the Schwab's Total Market fund staying the course? Is Vanguard's Total Market fund invested in the exact same stocks as Schwab's Total Market fund?
almostretired1965
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Re: Please help me understand tax loss harvesting

Post by almostretired1965 »

sailaway wrote: Sun Feb 11, 2024 4:35 pm You reinvest the money into something similar. If you sell an SP500 fund, you can purchase a total market fund, for example. This way, your money isn't out of the market and you aren't trying to guess at when to get back in.

You aren't necessarily getting a benefit on the capital gains, as you are repurchasing with a lower cost basis. The main benefit is from the max $3k offset of ordinary income.

Personally, I can't get as excited about it as some other folks do. Perhaps just because we are in a lower tax bracket?
So that's the situation I am in. The last 2 years of tax loss harvesting has allowed me to avoid close to $100K in cap gains I would have had to pay taxes on plus another $6k off of ordinary income. I am in the 35% bracket and subject to the net investment tax. All used up for the most part so that's it for now.
toddthebod
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Re: Please help me understand tax loss harvesting

Post by toddthebod »

timmarkell wrote: Sun Feb 11, 2024 4:56 pm
toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
How is switching from Vanguard's Total Market fund to the Schwab's Total Market fund staying the course? Is Vanguard's Total Market fund invested in the exact same stocks as Schwab's Total Market fund?
It's close enough without being the same. Whether you invest in Vanguard's, Fidelity's, Schwab's, Blackrock's, or anyone else's total market fund or large cap fund or S&P 500 fund or Russell 1000 fund, you can expect virtually identical outcomes (like 99% correlation between them all). It is staying the course in the sense that, on Monday, you are invested in a broad market equity index fund with a certain percentage of your assets, and on Tuesday you are still invested in a broad market equity index fund with the same percentage of your assets, yet by switching funds, you are able to realize capital losses and take advantage of certain tax rules.
Backtests without cash flows are meaningless. Returns without dividends are lies.
Topic Author
timmarkell
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Joined: Mon Dec 24, 2012 10:40 am

Re: Please help me understand tax loss harvesting

Post by timmarkell »

toddthebod wrote: Sun Feb 11, 2024 5:10 pm
timmarkell wrote: Sun Feb 11, 2024 4:56 pm
toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
How is switching from Vanguard's Total Market fund to the Schwab's Total Market fund staying the course? Is Vanguard's Total Market fund invested in the exact same stocks as Schwab's Total Market fund?
It's close enough without being the same. Whether you invest in Vanguard's, Fidelity's, Schwab's, Blackrock's, or anyone else's total market fund or large cap fund or S&P 500 fund or Russell 1000 fund, you can expect virtually identical outcomes (like 99% correlation between them all). It is staying the course in the sense that, on Monday, you are invested in a broad market equity index fund with a certain percentage of your assets, and on Tuesday you are still invested in a broad market equity index fund with the same percentage of your assets, yet by switching funds, you are able to realize capital losses and take advantage of certain tax rules.
Ok I get it now. Thank you
Topic Author
timmarkell
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Re: Please help me understand tax loss harvesting

Post by timmarkell »

It seems to me that this tax loss harvesting would only be worth the trouble of bothering with for a person with a lot of money invested in mutual funds. Would tax loss harvesting be worth the trouble for a person with less than $100,000 invested in mutual funds?
toddthebod
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Re: Please help me understand tax loss harvesting

Post by toddthebod »

timmarkell wrote: Sun Feb 11, 2024 6:51 pm It seems to me that this tax loss harvesting would only be worth the trouble of bothering with for a person with a lot of money invested in mutual funds. Would tax loss harvesting be worth the trouble for a person with less than $100,000 invested in mutual funds?
Considering it takes 5 minutes to place a trade these days, I'd say it's worth doing for anyone with more than a few thousand dollars in losses.
Backtests without cash flows are meaningless. Returns without dividends are lies.
Topic Author
timmarkell
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Re: Please help me understand tax loss harvesting

Post by timmarkell »

toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
Something else just occurred to me. Let's say a person sells Vanguard's Total Market Fund and buy the same amount of Schwab's Total Market fund. When the Schwab's Total Market fund eventually goes up in value (maybe many years later), the person is going to have the capital gains taxes on the Schwab Total Market fund when they sell it. So is the strategy described in the Bogleheads book really going to reduce the total amount of taxes a person pays in a lifetime?

I don't see how it would. It seems to me it would likely just defer the paying of taxes because the Schwab Total Market fund will probably eventually increase substantially in value.
toddthebod
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Joined: Wed May 18, 2022 12:42 pm

Re: Please help me understand tax loss harvesting

Post by toddthebod »

timmarkell wrote: Sun Feb 11, 2024 7:47 pm
toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
Something else just occurred to me. Let's say a person sells Vanguard's Total Market Fund and buy the same amount of Schwab's Total Market fund. When the Schwab's Total Market fund eventually goes up in value (maybe many years later), the person is going to have the capital gains taxes on the Schwab Total Market fund when they sell it. So is the strategy described in the Bogleheads book really going to reduce the total amount of taxes a person pays in a lifetime?

I don't see how it would. It seems to me it would likely just defer the paying of taxes because the Schwab Total Market fund will probably eventually increase substantially in value.
There are a few considerations:
1. You can deduct $3,000 of capital losses every year against ordinary income. Ordinary income tax rates are higher than long-term capital gains rates, so at worst you can pay additional long-term capital gains taxes in exchange for less ordinary income taxes.
2. A dollar today is worth more than a dollar tomorrow, so simply taking a loss this year and paying for the gain next year is a win even at the same tax rates.
3. There are ways to avoid paying capital gains taxes forever: dying, donating, or selling when your income is low enough to be in the 0% long term capital gains bracket (<$94,050 for a married couple filing jointly).
Backtests without cash flows are meaningless. Returns without dividends are lies.
livesoft
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Re: Please help me understand tax loss harvesting

Post by livesoft »

timmarkell wrote: Sun Feb 11, 2024 7:47 pm I don't see how it would. It seems to me it would likely just defer the paying of taxes because the Schwab Total Market fund will probably eventually increase substantially in value.
Yes, it would, but one has to think outside of the box.

The harvested losses are not just used to offset capital gains. Instead, the harvested losses are used to offset some ordinary income that has a higher tax rate than long-term capital gains. Furthermore, if one has carryover losses into the future when one no longer has earned income (say in retirement), then those losses may offset capital gains to put the rest of one's capital gains in the 0% tax rate.

Also, if one has to rebalance by selling something in a taxable account, the previously harvested losses can prevent your mind from being clouded up by "I can't sell to rebalance because I will have to pay a tax cost."
Last edited by livesoft on Sun Feb 11, 2024 8:03 pm, edited 1 time in total.
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arcticpineapplecorp.
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Re: Please help me understand tax loss harvesting

Post by arcticpineapplecorp. »

timmarkell wrote: Sun Feb 11, 2024 6:51 pm It seems to me that this tax loss harvesting would only be worth the trouble of bothering with for a person with a lot of money invested in mutual funds. Would tax loss harvesting be worth the trouble for a person with less than $100,000 invested in mutual funds?
I helped my mom TLH in 2022 and even though she didn't have $100k invested at that time in taxable, she was able to take $3000 in losses which helped her reduce her federal taxes by $660 (22% bracket, see?).

So that saved her $660 or got her that refund if she didn't owe. That's real money. $660 can cover a lot of meals out.

The market fell 25% in 2022 so to generate $3000 in losses you could have bought $12,000 in January and sold when the market fell 25%. You didn't need $100k.

Also as was said you can carryover losses if you don't use them up in one year. This can be very helpful in later years depending on how many losses you have.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
Topic Author
timmarkell
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Re: Please help me understand tax loss harvesting

Post by timmarkell »

toddthebod wrote: Sun Feb 11, 2024 7:55 pm
timmarkell wrote: Sun Feb 11, 2024 7:47 pm
toddthebod wrote: Sun Feb 11, 2024 4:34 pm
timmarkell wrote: Sun Feb 11, 2024 4:25 pm On pages 127 and 128 of the book The Bogleheads Guide to Investing, the authors write, "To understand how tax-loss harvesting works, let's assume it's December 2007. During the year you sold or exchanged one of your taxable funds for a $2,000 profit. You also have another fund with a $6,000 loss. Here's what you should do:

1# Before the year-end, sell the losing $6,000 fund.

2# Use $2,000 of the tax-loss to offset the $2,000 gain on the profitable fund. This leaves a $4,000 tax-loss balance

3# Use $3,000 of the balance (the maximum allowed) to reduce your income reported on the first page of your 2006 income tax return. You are then left with a $1,000 tax-loss balance.

4# This $1,000 balance will be a "capital loss carryover" to 2008."

I can see how this would be more tax-efficiency, but, to me, there seems to be a problem. I have always heard and read that one of the core maxims of the Boglehead investing strategy is: "Stay the course no matter what!" In other words, I have always heard and read that the Boglehead investing strategy is to NEVER sell your funds because the funds decrease in value. Yet on the example of tax loss harvesting on page 128, the first step is: "1# Before the year-end, sell the losing $6,000 fund".

How does step 1# "Before the year-end, sell the losing $6,000 fund" not violate the Boglehead maxim to stay the course no matter what?
The missing detail is that you sell the losing fund and immediately buy a different fund that accomplishes the same investing goal (e.g., selling Vanguard's Total Market fund and buying Schwab's or Blackrock's total market fund). This both allows you to "stay the course" while also realizing capital losses.
Something else just occurred to me. Let's say a person sells Vanguard's Total Market Fund and buy the same amount of Schwab's Total Market fund. When the Schwab's Total Market fund eventually goes up in value (maybe many years later), the person is going to have the capital gains taxes on the Schwab Total Market fund when they sell it. So is the strategy described in the Bogleheads book really going to reduce the total amount of taxes a person pays in a lifetime?

I don't see how it would. It seems to me it would likely just defer the paying of taxes because the Schwab Total Market fund will probably eventually increase substantially in value.
There are a few considerations:
1. You can deduct $3,000 of capital losses every year against ordinary income. Ordinary income tax rates are higher than long-term capital gains rates, so at worst you can pay additional long-term capital gains taxes in exchange for less ordinary income taxes.
2. A dollar today is worth more than a dollar tomorrow, so simply taking a loss this year and paying for the gain next year is a win even at the same tax rates.
3. There are ways to avoid paying capital gains taxes forever: dying, donating, or selling when your income is low enough to be in the 0% long term capital gains bracket (<$94,050 for a married couple filing jointly).
When I made that post, I forgot about the fact that ordinary income tax rates are higher than long term capital gain tax rates. Good point. Now I see how tax loss harvesting to reduce capital gain taxes can reduce the total amount of taxes paid in a lifetime.
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arcticpineapplecorp.
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Re: Please help me understand tax loss harvesting

Post by arcticpineapplecorp. »

timmarkell wrote: Sun Feb 11, 2024 7:47 pm Something else just occurred to me. Let's say a person sells Vanguard's Total Market Fund and buy the same amount of Schwab's Total Market fund. When the Schwab's Total Market fund eventually goes up in value (maybe many years later), the person is going to have the capital gains taxes on the Schwab Total Market fund when they sell it. So is the strategy described in the Bogleheads book really going to reduce the total amount of taxes a person pays in a lifetime?

I don't see how it would. It seems to me it would likely just defer the paying of taxes because the Schwab Total Market fund will probably eventually increase substantially in value.
It's true the money you're getting from selling at a loss you're reinvesting in something similar, but not identical that will likely recover and you have gains later. But just because you have gains, doesn't mean you have to ever sell it and pay taxes.

You could pass it on to kids after death and they get a step up in basis.
You could gift it to kids and let them assume your cost basis.
You could donate it to charity or a donor advised fund (get a tax deduction to boot, if you itemize)
You could sell when you have extraordinary medical expenses (think long term care) and if medical expenses equal/exceed income, you have no tax liability.

Finally if you do TLH but stay invested, you can bank losses to reduce/eliminate gains later from securities sold at a gain.

One final thing to mention (not yet mentioned) it's possible the example in the book was talking about before end of year, also to lock in short term losses. If you don't take advantage of losses when they occur, the stock could recover and you're looking at gains. So you should clear the deck each year rather than possibly turn short term losses into long term gains.
It's hard to accept the truth when the lies were exactly what you wanted to hear. Investing is simple, but not easy. Buy, hold & rebalance low cost index funds & manage taxable events. Asking Portfolio Questions | Wiki
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