What is tax loss harvesting?
Tax loss harvesting is a way to use investment losses to lower your tax bill. If you sell an asset for less than you paid, you realize a loss. You can use that loss to offset gains you made elsewhere. If losses exceed gains, you can reduce ordinary income up to a limit and carry the rest forward to future years.
It sounds technical, but the idea is simple. Turn losses into tax savings.
How it works, step by step
- You sell an investment that has dropped in value.
- You record the loss for tax purposes.
- You use that loss to offset capital gains from other sales.
- If losses are bigger than gains, you can offset up to $3,000 of regular income per year in the U.S. The rest can be carried forward.
This lowers the taxes you owe now. It does not change your actual investment risk by itself. You still own similar assets if you want to stay invested.
The wash sale rule
The wash sale rule stops people from selling a losing investment just to get a tax break, then immediately buying it back. If you buy the same or a "substantially identical" security within 30 days before or after the sale, the loss is disallowed for tax purposes.
Key points about the wash sale rule:
- It applies to stocks and bonds and many ETFs. It also applies across accounts. If you sell a loss in a taxable account and buy the same security in an IRA within 30 days, the rule can apply.
- The 30-day window is strict. Count both sides: 30 days before and 30 days after the sale.
- If the rule applies, the loss is deferred and added to the basis of the replacement security. That changes future taxes but does not give an immediate benefit.
To avoid wash sales, use different securities with similar exposure, or wait 31 days before buying back the same fund.
Example
You bought 100 shares of Fund A for $10,000. Now it is worth $7,000. You sell and realize a $3,000 loss. You also sold other stocks this year and had $2,000 in gains.
- Use $2,000 of the loss to cancel the gains.
- That leaves $1,000 of net loss.
- You can use up to $3,000 of net losses to reduce ordinary income. So you deduct the remaining $1,000 from your income this year.
- No loss carryforward is needed in this simple case.
If you instead had no gains, you could deduct $3,000 of ordinary income and carry the rest to future years.
Common strategies
- Replace with a similar ETF. If you sell S&P 500 Fund A at a loss, buy a total market ETF instead. You keep market exposure without triggering a wash sale.
- Use ETFs instead of single stocks when possible. ETFs give broad exposure and make replacement choices easier.
- Harvest losses each year. Many investors do a tax harvest at year end. Markets move, and losses can appear.
- Automate with robo-advisors. Some services handle harvesting automatically across many accounts.
Costs and tradeoffs
Tax benefits are real, but there are costs.
- Transaction fees and spreads. Trading costs can erode savings.
- Loss of a specific tax lot basis. If you replace a holding, your future gains and losses change.
- Behavioral risk. Churning trades to harvest taxes can lead to worse investment decisions.
- Wash sale mistakes across accounts. That can ruin the tax benefit and create headaches.
Do the math. A small loss might not be worth trading costs or taxes on future gains.
When it makes sense
Tax loss harvesting usually helps if:
- You have taxable accounts with losses.
- You expect to be in a similar or higher tax rate later.
- You can avoid wash sales while keeping similar market exposure.
- Trading costs are low.
It is less helpful if:
- You are taxed lightly or hold everything in tax-advantaged accounts.
- The loss is tiny and fees would eat the benefit.
- The sale ruins a long term plan, like losing position in a core holding you want to keep.
Record keeping
Keep clear records of:
- Dates and amounts of purchases and sales.
- Cost basis for each lot.
- Any replacement purchases within 30 days.
- Statements that show the transactions.
Good records make it easy to report on your taxes and avoid mistakes with wash sales.
Bottom line
Tax loss harvesting is a legal way to use investment losses to cut taxes now or in the future. It works best when you plan trades to avoid wash sales and keep costs low. For big decisions, talk to a tax pro or a financial advisor. They can show how much harvesting will save you in your specific situation.