Tax-loss harvesting is one of the most powerful yet underutilized tax strategies available to investors. By strategically selling losing investments to offset gains, you can save thousands in taxes annually while maintaining your investment strategy.
How Tax-Loss Harvesting Works
Tax-loss harvesting is the practice of selling investments that have declined in value to realize a capital loss, which can offset capital gains and reduce your tax bill.
The Basic Concept
Find investments trading below your purchase price (unrealized losses)
Sell the losing position, converting unrealized loss to realized loss for tax purposes
Use realized losses to offset capital gains from other investments (or deduct $3,000 against ordinary income)
Immediately buy a similar (but not identical) investment to maintain market exposure
Your 2024 investment activity:
- Bought: $10,000 in January
- Sold: $15,000 in November
- Capital Gain: $5,000
- Bought: $8,000 in March
- Current value: $5,000
- Unrealized Loss: $3,000
Without Tax-Loss Harvesting:
- Capital gains: $5,000
- Tax owed (20% long-term rate): $1,000
With Tax-Loss Harvesting:
- Sell Tesla, realize $3,000 loss
- Immediately buy similar EV stock or auto sector ETF (avoid wash sale)
- Net capital gain: $5,000 - $3,000 = $2,000
- Tax owed (20% rate): $400
- Tax savings: $600
You saved $600 in taxes while maintaining exposure to EV stocks. Tesla's loss became a valuable tax asset.
The Wash-Sale Rule: The Most Important Rule
The wash-sale rule prevents you from claiming a tax loss if you buy the same or "substantially identical" security within 30 days before or after the sale.
What Triggers a Wash Sale
A wash sale occurs if you buy a "substantially identical" security within the 61-day window: 30 days before the sale + day of sale + 30 days after = 61 days total.
Examples of Wash Sales (Disallowed):
- ✗ Sell Apple stock for a loss, buy Apple stock again within 30 days
- ✗ Sell Vanguard S&P 500 ETF (VOO), buy it back within 30 days
- ✗ Sell Tesla in taxable account, buy Tesla in IRA within 30 days
- ✗ Sell a stock, have your spouse buy the same stock within 30 days
- ✗ Sell Microsoft, buy call options on Microsoft within 30 days
How to Avoid Wash Sales (Allowed):
- ✓ Sell VOO (Vanguard S&P 500), immediately buy IVV (iShares S&P 500) - different issuers
- ✓ Sell Apple, immediately buy Microsoft or tech sector ETF
- ✓ Sell small-cap index, buy mid-cap index
- ✓ Wait 31 days, then buy back the exact same security
- ✓ Sell individual stock, buy sector ETF containing that stock (not substantially identical)
Timeline:
- Jan 1: Buy 100 shares Apple at $180 = $18,000
- Oct 15: Apple drops to $150. Sell all shares = $15,000 (realize $3,000 loss)
- Nov 5: Apple rebounds to $160. You rebuy 100 shares = $16,000
Result: Wash sale violation!
You bought substantially identical security (Apple) within 30 days after the sale (Oct 15 → Nov 5 = 21 days).
Tax consequence: The $3,000 loss is disallowed for this year. Instead, it's added to the cost basis of your new shares.
New cost basis: $16,000 + $3,000 disallowed loss = $19,000
Solution: Instead of buying Apple back, buy Microsoft or tech ETF (XLK, VGT) on Nov 5. Maintain tech exposure without triggering wash sale. Buy Apple back after 31 days (Nov 15+) if desired.
The $3,000 Annual Deduction
Even if you have no capital gains to offset, you can deduct up to $3,000 of net capital losses against ordinary income (W-2 wages, business income) each year.
How the $3,000 Deduction Works
Scenario: You're in the 24% tax bracket with $80,000 W-2 income.
- Year 1: Market crashes. You harvest $10,000 in losses but have $0 capital gains.
- Deduct: $3,000 against ordinary income
- Tax savings: $3,000 × 24% = $720
- Carry forward: $7,000 to next year
- Year 2: You realize $5,000 capital gains, no new losses.
- Use $5,000 from carry-forward to offset gains → $0 tax on gains
- Deduct additional $2,000 against income (remaining carry-forward)
- Tax savings: ($5,000 × 20%) + ($2,000 × 24%) = $1,000 + $480 = $1,480
- Total tax savings from $10,000 harvested losses: $2,200
Important Rules:
- Married filing jointly: $3,000 limit (not $6,000)
- Married filing separately: $1,500 limit each
- Priority: Losses first offset capital gains, then up to $3,000 against income
- Unused losses carry forward indefinitely (no expiration)
The $3,000 deduction is like a yearly coupon worth $600-1,200 in tax savings. Most investors throw it away by not harvesting losses. Don't be one of them.
— Tax Advisor Saying
Carrying Forward Losses Indefinitely
Capital losses you don't use this year don't disappear—they carry forward to future years with no expiration date.
- Harvest $25,000 in losses (COVID crash)
- Capital gains: $0
- Deduct $3,000 against income → Save $720 (24% bracket)
- Carry forward: $22,000
- Realize $15,000 capital gains
- Use $15,000 from carry-forward → Offset all gains
- Deduct additional $3,000 against income
- Tax savings: ($15,000 × 20%) + ($3,000 × 24%) = $3,000 + $720 = $3,720
- Carry forward: $4,000
- Realize $10,000 capital gains
- Use $4,000 from carry-forward → Offset $4,000 of gains
- Tax on remaining $6,000 gains: $6,000 × 20% = $1,200
- Tax savings from carry-forward: $4,000 × 20% = $800
- Carry forward: $0 (fully used)
Total tax savings from $25,000 harvested losses:
2020: $720 + 2021: $3,720 + 2022: $800 = $5,240 saved over 3 years
That $25,000 loss turned into a $5,240 "tax refund" spread across multiple years.
Step-by-Step: How to Execute Tax-Loss Harvesting
Complete Walkthrough
- Step 1: Review Your Portfolio (November-December)
Log into your brokerage. Run a "Cost Basis" or "Unrealized Gains/Losses" report. Identify positions with losses >5% (worth harvesting).
- Step 2: Calculate Your Tax Situation
Do you have capital gains this year (from stock sales, mutual fund distributions)? How much? If gains > losses, prioritize offsetting those first.
- Step 3: Identify Replacement Securities
For each losing position, find a similar-but-not-identical replacement:
• VOO → IVV (both S&P 500, different issuers)
• VTI → ITOT (both total market, different issuers)
• Tech stock → Tech sector ETF (XLK, VGT) - Step 4: Execute Simultaneously
Same day: Sell losing position (realizes loss), immediately buy replacement (maintains exposure). No gap = no market risk.
- Step 5: Track Wash-Sale Window
Mark calendar: Do not buy original security for 31 days. Set reminder for Day 32 if you want to swap back.
- Step 6: Document for Taxes
Your brokerage will report on Form 1099-B. If you swap back within 31 days, brokerage may flag wash sale. Double-check in February when 1099s arrive.
November 15, 2024 - 10:00 AM EST:
Security: Nvidia (NVDA)
Quantity: 50 shares
Purchase price: $500/share ($25,000 cost basis)
Current price: $400/share
Sale proceeds: $20,000
Realized Loss: $5,000
Security: VanEck Semiconductor ETF (SMH) - similar exposure, not identical
Investment: $20,000
Shares: ~120 shares at $167/share
Result: You've realized $5,000 tax loss (saves $1,000-1,500 in taxes) while maintaining semiconductor sector exposure. No wash sale because SMH ≠NVDA. On December 17 (Day 32), you can sell SMH and buy back NVDA if desired.
When to Harvest Losses: Optimal Timing
Year-End Tax-Loss Harvesting (November-December)
The traditional window. Most investors harvest losses in final two months to offset current-year gains.
- Pros: Know your full year's gains, can optimize precisely
- Cons: Everyone does it → possible selling pressure on losers in December
Opportunistic Harvesting (Year-Round)
Harvest losses whenever they appear, especially after market corrections.
- Pros: Capture larger losses immediately, spreads out activity
- Cons: Requires monitoring, may harvest losses you don't need
Best Practice: Hybrid Approach
Harvest large losses (10%+) opportunistically when they occur. Do a year-end sweep in November/December to capture smaller losses and optimize final tax bill.
Trigger Points to Harvest
- Market corrections (10%+ drops): Broad losses create harvesting opportunities across portfolio
- Individual stock earnings misses: Stock drops 15%+ → harvest, swap to competitor or sector ETF
- Large unrealized gains elsewhere: If you sold winners, harvest losers to offset
- December 31 approaching: Last chance to realize losses for current tax year
Automation Tools: Set-and-Forget Tax-Loss Harvesting
Modern robo-advisors automate tax-loss harvesting daily, capturing thousands in tax savings without manual effort.
| Platform | Tax-Loss Harvesting | Minimum | Fee |
|---|---|---|---|
| Wealthfront | Daily automated TLH | $500 | 0.25% |
| Betterment | Daily automated TLH | $0 | 0.25% |
| Vanguard Personal Advisor | Annual TLH review | $50,000 | 0.30% |
| Schwab Intelligent Portfolios | Automated TLH (premium only) | $25,000 | 0.30% |
Portfolio: $200,000 at Wealthfront (0.25% fee = $500/year)
Annual TLH benefit (conservative estimate):
Wealthfront harvests ~$4,000 in losses annually on average
Tax savings: $4,000 × 25% bracket = $1,000/year
Net benefit: $1,000 tax savings - $500 fee = +$500/year
30-year compounding impact:
Reinvesting $1,000 annual tax savings at 8% return
Future value: $113,000
The robo-advisor fee pays for itself through tax savings, with $500/year profit. Over decades, automated TLH can add six figures to your wealth.
Common Mistakes to Avoid
7 Costly Tax-Loss Harvesting Errors
Buying back the same security within 30 days. Solution: Use different ETF issuers (VOO → IVV) or wait 31 days.
IRAs and 401(k)s grow tax-deferred—losses provide zero benefit. Only harvest in taxable brokerage accounts.
Don't sell a great long-term investment just to harvest a small loss. Only harvest if you're comfortable owning the replacement.
Harvesting a $200 loss when trades cost $100 round-trip = net $50 tax benefit (not worth it). Use commission-free brokers.
"Day 28... close enough to 31, right?" Wrong. IRS counts calendar days. Day 32 is the first safe day.
Selling right before ex-dividend date means you miss the dividend. Check ex-dates before harvesting dividend stocks.
Selling Apple in taxable account while simultaneously buying Apple in IRA = wash sale. Track all accounts (including spouse's).
The wash-sale rule has no mercy. The IRS will disallow your loss even if you accidentally triggered it. When in doubt, use a different security or wait 31 days. A small delay is better than losing thousands in tax benefits.
— CPA Maxim
Conclusion: Free Money on the Table
Tax-loss harvesting is one of the few "free lunches" in investing. It reduces your tax bill while maintaining your investment strategy—pure alpha with no downside.
Your Tax-Loss Harvesting Action Plan
Lifetime Impact: The Power of Annual Harvesting
Conservative scenario: Harvest $5,000 losses annually for 30 years
- Annual tax savings: $5,000 × 25% = $1,250
- Reinvest savings at 8% return
- 30-year future value: $141,000
Tax-loss harvesting can add $100,000-200,000 to your retirement portfolio through compounded tax savings. It's the highest-ROI activity per hour of effort in all of investing.
Tax-loss harvesting is the closest thing to financial alchemy—turning losses into gold. Master the wash-sale rule, harvest opportunistically, and automate if possible. Your future tax-free self will thank you.