Tax-Loss Harvesting — Turn Losses Into Savings

Losing money is never fun. But it can lower your tax bill.

How Tax-Loss Harvesting Works

When you sell an investment for less than you paid, you realize a capital loss. That loss can offset capital gains dollar for dollar. If your losses exceed your gains, you can deduct up to $3,000 against ordinary income per year. Any remaining losses carry forward indefinitely to future years.

The key insight: you don't have to abandon your investment thesis. You sell the losing position, immediately buy a similar (but not identical) investment, and stay invested — while banking a tax deduction.

Step-by-Step Example

• 1. You own $15,000 of a tech ETF — now worth $10,000. You're sitting on a $5,000 unrealized loss. The market dropped, but you still believe in the long-term thesis.

• 2. Sell the position and realize the $5,000 loss. You now have a $5,000 capital loss locked in, usable to offset $5,000 of capital gains from other investments.

• 3. Immediately buy a similar (not identical) ETF. You reinvest in a different tech ETF or a total market ETF, maintaining your market exposure while the 30-day wash-sale window passes.

• 4. Use the loss to offset gains or income. $5,000 loss offsets $5,000 of capital gains. If you have no gains, you can deduct $3,000 against ordinary income this year and carry the remaining $2,000 forward.

The wash-sale rule — the #1 mistake to avoid: If you sell a security at a loss and buy the same or substantially identical security within 30 days before or after the sale, the IRS disallows the loss. The 30-day window goes both directions — you can't buy first, sell at a loss, and buy again.

Note: "Substantially identical" isn't perfectly defined by the IRS. When in doubt, choose a fund with a clearly different index or broader scope.

How Losses Are Applied

The IRS has a specific netting order for capital gains and losses:

• 1. Short-term losses offset short-term gains first.

• 2. Long-term losses offset long-term gains first.

• 3. Net short-term loss offsets net long-term gain (or vice versa) — cross-netting after same-type is exhausted.

• 4. Remaining net loss offsets up to $3,000 of ordinary income — reduces W-2/1099 income directly.

• 5. Any remaining loss carries forward to next year, indefinitely, with no expiration.

What a $10,000 Harvested Loss Is Worth

Assuming a $10,000 harvested loss applied to gains:

Best use: offset short-term gains first — highest tax rate saved.

When Does Tax-Loss Harvesting Make Sense?

• ✅ You have realized or expected capital gains this year — if you've already sold winners or plan to, harvesting losses directly offsets those gains, potentially at a 15–20% savings rate.

• ✅ You're in a taxable brokerage account — tax-loss harvesting only applies to taxable accounts. Gains and losses inside IRAs and 401(k)s have no tax impact since they're already tax-advantaged.

• ✅ You have large unrealized losses during market downturns — market corrections are prime harvesting opportunities. A 20% drop creates significant losses to harvest while you stay invested via a replacement fund.

• ❌ You're in a very low income year (0% LTCG bracket) — if you're already paying 0% on long-term gains, harvesting losses has limited value. You may actually want to harvest gains at 0% instead.

Automate it — robo-advisors do this continuously. Platforms like Betterment, Wealthfront, and Fidelity's managed accounts scan your portfolio daily for harvesting opportunities. For significant taxable portfolios (typically $100K+), automated harvesting can generate meaningful annual savings. If you manage your own portfolio, a year-end review in November–December is a good time to scan for positions with unrealized losses before the tax year closes.

Common Mistakes to Avoid

• Triggering a wash sale by mistake: Buying back the same or a substantially identical security within 30 days before or after the sale gets the loss disallowed — the window runs in both directions, so buying first and selling later counts too.

• Harvesting losses in a 0% long-term gains year: If your taxable income is already low enough to pay 0% on long-term gains, a harvested loss has little value — it may be better to harvest gains tax-free instead.

• Trying to harvest losses inside a retirement account: Tax-loss harvesting only matters in taxable brokerage accounts — gains and losses inside an IRA or 401(k) have no tax impact since those accounts are already tax-advantaged.

Key Terms

• Tax-Loss Harvesting: the practice of selling an investment at a loss to generate a capital loss that offsets capital gains — or up to $3,000 of ordinary income per year — reducing your current tax bill.

• Wash-Sale Rule: an IRS rule that disallows a capital loss if you buy the same or a "substantially identical" security within 30 days before or after the sale. The loss isn't gone forever — it's added to the cost basis of the new shares.

• Capital Loss Carryforward: if your capital losses exceed gains plus the $3,000 ordinary income limit, the unused losses carry forward indefinitely to future tax years.

• Substantially Identical: two securities are substantially identical if they represent the same economic exposure. Selling SPY and buying VOO (both S&P 500 ETFs) may trigger the wash-sale rule; selling SPY and buying a total market ETF typically does not.

Quick Summary

• Sell losers to realize capital losses — use them to offset gains or up to $3,000 of ordinary income

• Stay invested by immediately buying a similar (not identical) replacement fund

• Wash-sale rule: no buying back the same or substantially identical security within 30 days before or after the sale

• Unused losses carry forward indefinitely — no expiration

• Only applies to taxable accounts — IRAs/401(k)s are already tax-sheltered

• Best time to harvest: market downturns, or when you have significant gains to offset

Frequently Asked Questions