What Is Tax-Loss Harvesting?
Tax-loss harvesting is a strategy where you intentionally sell investments at a loss to reduce your tax bill. It's one of the few "silver linings" when investments decline - you can use those losses to offset capital gains elsewhere.
Think of it like this: if you had a $5,000 gain and a $5,000 loss in the same year, you could "harvest" that loss to completely offset the gain, owing zero capital gains tax.
Key insight: Tax-loss harvesting doesn't make losses "good" - you still lost money. But it does let you reduce your tax bill, which softens the blow. It's about making the best of a bad situation.
How Tax-Loss Harvesting Works
When you sell an investment at a loss, that loss can reduce your taxes in two ways:
1. Offset Capital Gains
Losses offset gains dollar-for-dollar. Short-term losses first offset short-term gains, then long-term gains. Long-term losses offset long-term gains first, then short-term.
2. Deduct From Ordinary Income
If losses exceed gains, you can deduct up to $3,000 of net capital losses against ordinary income (like your salary). Any excess carries forward to future years.
Taxable accounts only:
Tax-loss harvesting only works in taxable brokerage accounts. In tax-advantaged accounts (401(k), IRA), gains and losses aren't taxed annually, so there's nothing to harvest.
The Wash Sale Rule
There's a catch. The IRS doesn't want you to sell just to claim a loss and immediately buy back the same investment. The wash sale rule prevents this.
The 30-Day Rule:
You cannot claim a tax loss if you buy the same or substantially identical security within 30 days before or after the sale. That's a 61-day window total (30 days before + sale day + 30 days after).
If you trigger a wash sale, your loss isn't lost forever - it gets added to the cost basis of your replacement shares. But you can't claim it now.
| Triggers Wash Sale? | Action |
|---|---|
| Yes | Buy same stock within 30 days |
| Yes | Buy same ETF within 30 days |
| Maybe | Buy similar ETF from different provider |
| No | Wait 31+ days to repurchase |
Step-by-Step Tax-Loss Harvesting
Identify investments with losses
Review your portfolio for positions trading below your cost basis.
Consider if selling makes sense
Do you still believe in the investment? Would you buy it again at this price?
Sell to realize the loss
Execute the sale. The loss is now realized and can offset gains.
Reinvest in something similar (optional)
To stay invested, buy a similar but not identical investment to avoid the wash sale rule. For example, if you sell VTI (Vanguard Total Stock Market), you could buy SCHB (Schwab Broad Market) or ITOT (iShares Core S&P Total). They track similar indexes but are not "substantially identical."
Track for your tax return
Your broker reports sales on Form 1099-B. Report capital gains/losses on Schedule D.
When to Harvest Losses
Tax-loss harvesting is most valuable when:
- You have significant capital gains to offset
- You're in a high tax bracket (more benefit from deductions)
- It's late in the year and you know your tax situation
- Markets have declined, creating loss opportunities
- You want to rebalance anyway
Year-end note: Many investors harvest losses in December to offset gains from the year. But you can harvest anytime. If the market drops 20% in March and you have losses, you don't have to wait until December.
Note: Tax-loss harvesting defers taxes rather than eliminating them. When you eventually sell the replacement investment, your gains will be calculated from the new (lower) cost basis. Consult a tax professional to understand if this strategy makes sense for your situation.
Now you understand how to turn investment losses into tax savings. Next, we'll look at how dividends are taxed differently.