Key Takeaway
Tax-loss harvesting can save you $3,000+ annually in taxes against ordinary income, plus unlimited offset against capital gains. It's one of the few "free lunch" strategies in investing.
Nobody likes seeing their investments drop in value. But here's a silver lining: those paper losses can become real tax savings through a strategy called tax-loss harvesting.
This guide will teach you exactly how it works, the rules you need to follow, and whether it makes sense for your situation. By the end, you'll understand one of the most powerful (and underutilized) tax strategies available to individual investors.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is the practice of selling investments at a loss to offset taxes on capital gains and income. You're essentially "harvesting" your paper losses to create real tax benefits.
The Basic Concept
Without Tax-Loss Harvesting:
- ✗You sold Stock A for $10,000 gain
- •Stock B is down $8,000 (unrealized)
- ✗Tax owed: $1,500 (15% on $10k gain)
With Tax-Loss Harvesting:
- ✓You sold Stock A for $10,000 gain
- ✓You sell Stock B to realize $8,000 loss
- ✓Tax owed: $300 (15% on net $2k gain)
- →You saved $1,200 in taxes!
💡 The Best Part
After selling Stock B, you can immediately buy a similar investment to maintain your market exposure. Your portfolio stays essentially the same—but your tax bill drops significantly.
The Wash Sale Rule
The IRS anticipated that people might try to sell at a loss and immediately buy the same thing back. So they created the wash sale rule to prevent this.
The Wash Sale Rule
You cannot claim a loss if you buy a "substantially identical" security within 30 days before or after the sale.
❌ Triggers Wash Sale:
- • Buying the exact same stock/fund
- • Buying in an IRA within 30 days
- • Spouse buying same security
- • Dividend reinvestment purchases
✓ Allowed Replacements:
- • Different company in same sector
- • Different index fund (e.g., S&P vs. Total Market)
- • Waiting 31 days to repurchase
- • ETF version of mutual fund (debated)
📅 The 61-Day Window
The total "prohibited" window is 61 days (30 before + sale day + 30 after)
Step-by-Step Example
Let's walk through a real-world example to see exactly how tax-loss harvesting works in practice.
📊 Sarah's Situation
- •Owns VTI (Vanguard Total Stock Market ETF): Bought for $50,000, now worth $42,000
- •Also sold some Apple stock earlier this year: $15,000 capital gain
- •Combined federal + state tax rate on long-term gains: 20%
- •Marginal income tax rate: 32%
Identify the Loss
VTI unrealized loss = $50,000 - $42,000 = -$8,000
Sell VTI to Realize the Loss
Sarah sells all her VTI shares for $42,000. The $8,000 loss is now "realized" and can be used for taxes.
Buy a Similar (but Not Identical) Fund
Immediately, Sarah buys $42,000 of ITOT (iShares Core S&P Total US Stock Market ETF). This is a different fund tracking a similar index—not substantially identical.
Her portfolio exposure stays the same. She still owns the total US stock market.
Calculate the Tax Savings
Without harvesting:
$15,000 gain × 20% = $3,000 tax
With harvesting:
$15,000 - $8,000 = $7,000 net gain
$7,000 × 20% = $1,400 tax
Tax Savings: $1,600!
💡 What If Losses Exceed Gains?
If Sarah had no capital gains this year, she could still deduct up to $3,000 of the loss against her ordinary income (saving $960 at her 32% rate), and carry the remaining $5,000 forward to future years—forever, until it's used up!
When to Harvest (and When Not To)
Tax-loss harvesting isn't always the right move. Here's how to know when it makes sense:
✓Good Candidates for Harvesting
- •You have realized capital gains to offset
- •You're in a high tax bracket this year
- •Market downturn has created significant losses
- •You want to rebalance anyway
- •Year-end (before December 31)
✗Skip Harvesting When
- •You're in the 0% capital gains bracket
- •The loss is very small (not worth the effort)
- •You expect much higher income next year
- •Asset is in a tax-advantaged account (IRA/401k)
- •Transaction costs exceed tax savings
⚠️ The 0% Bracket Trap
In 2025, if your taxable income is under $47,025 (single) or $94,050 (married), your long-term capital gains rate is 0%.
If you're in this bracket, harvesting losses now could actually hurt you later. You'd be saving $0 in taxes now (since the rate is 0%), but you'd lower your cost basis—meaning more taxes later when you do sell. In this case, it's better to harvest gains, not losses!
Advanced Strategies
Strategy 1: Year-Round Monitoring
Don't wait until December. Opportunities appear throughout the year—especially during market volatility.
- •Set alerts for positions down 10%+ from purchase price
- •Market corrections are prime harvesting opportunities
- •Consider using robo-advisors that automate this process
Strategy 2: The "Swap" Approach
Have a pre-planned list of similar-but-not-identical replacement investments:
Strategy 3: Maximize the $3,000 Deduction
Even without capital gains, you can deduct $3,000 in losses against ordinary income every year. At high tax brackets, this is valuable:
Strategy 4: Specific Share Identification
If you've bought shares at different times, some may be at a loss while others are at a gain. Tell your broker to sell specific lots:
Example: You own 100 shares of XYZ
- • 50 shares bought at $100 (now worth $80) - Loss of $1,000
- • 50 shares bought at $50 (now worth $80) - Gain of $1,500
→ Specify to sell only the shares with losses to harvest the $1,000 loss!
7 Costly Mistakes to Avoid
Triggering a Wash Sale Unknowingly
Remember: dividend reinvestments, spouse purchases, and IRA buys all count. Turn off automatic reinvestment before harvesting.
Forgetting State Taxes
States have different rules. California doesn't allow $3,000 against income. New Jersey has its own wash sale rules. Check your state!
Harvesting in Tax-Advantaged Accounts
You CAN'T harvest losses in IRAs, 401(k)s, or HSAs. Losses in these accounts are lost forever for tax purposes.
Ignoring Transaction Costs
Commissions and bid-ask spreads can eat into savings. Make sure the tax benefit exceeds your costs.
Not Maintaining Exposure
If you sell and don't buy a replacement, you'll miss out if the market rebounds. Always have a swap plan ready.
Harvesting Losses at the Wrong Time
If you expect much higher income next year, those losses might be worth more then. Think strategically.
Poor Record Keeping
Track your harvested losses, carryovers, and cost basis adjustments. Use tax software or a spreadsheet.
Tools That Automate Tax-Loss Harvesting
| Service | Minimum | Fee | Notes |
|---|---|---|---|
| Betterment | $0 | 0.25% | Daily automatic harvesting |
| Wealthfront | $500 | 0.25% | Daily + direct indexing at $100k+ |
| Schwab Intelligent | $5,000 | $0 | Premium tier ($30/mo) includes TLH |
| Fidelity Go | $25,000 | 0.35% | Personalized, includes TLH |
📋 Tax-Loss Harvesting Checklist
Before Harvesting:
- Identify positions with unrealized losses
- Calculate potential tax savings
- Choose replacement investments
- Turn off dividend reinvestment
- Check for wash sale violations
After Harvesting:
- Buy replacement immediately
- Wait 31 days before buying original back
- Record new cost basis
- Track carryover losses
- Report on Schedule D at tax time
Calculate Your Potential Tax Savings
Use our tax planning tools to see how much you could save with strategic tax-loss harvesting.