Key Takeaways
- Selling a losing position banks a capital loss that offsets gains, plus up to $3,000 of ordinary income per year, with unlimited carryforward.
- The wash-sale rule disallows the loss if you buy the same or a substantially identical security within 30 days, in any account including your IRA.
- Harvesting mostly defers tax rather than eliminating it; the real wins are rate arbitrage and offsetting concentrated gains.
Tax-loss harvesting means selling an investment that has fallen below what you paid, capturing the loss for tax purposes, and immediately reinvesting in something similar so you stay invested. The banked loss offsets capital gains this year, then up to $3,000 of ordinary income, and anything left carries forward indefinitely.
Done well, it converts market volatility into tax savings without changing your portfolio's risk. Done carelessly, the wash-sale rule quietly disallows your losses. Here is how it actually works.
The Mechanics, Step by Step
Suppose you bought an index fund for $50,000 and it now trades at $41,000. You sell, realizing a $9,000 loss, and immediately buy a different but similar fund, say another broad-market index tracking a different benchmark index, so your market exposure never lapses. At tax time the $9,000 first cancels realized gains; any excess offsets up to $3,000 of ordinary income; the remainder carries forward to future years.
Your new position has a lower cost basis, which means a larger gain later. That is the fine print: harvesting mostly defers tax. Deferral still has value, and if the position is eventually donated or held until death, the deferred gain may never be taxed at all.
The Wash-sale Rule
The loss is disallowed if you purchase the same or a "substantially identical" security within 30 days before or after the sale. The rule spans all your accounts: buying the fund in your IRA, or via your 401(k)'s automatic contribution, or in a spouse's account, triggers it just as surely. Dividend reinvestment is a classic accidental trigger.
The practical defenses: pause automatic purchases of the harvested security everywhere for the window, swap into a similar-but-not-identical fund, and keep a simple log. Two broad index funds tracking different indexes are generally treated as not substantially identical, which is what makes the strategy workable.
Try it: the free The Wealth Checkup takes a couple of minutes and shows you where you stand. Or explore tax planning at Attend.
How Much Is It Really Worth?
Studies of systematic harvesting suggest a modest annual benefit that is largest in volatile years and for investors who regularly realize gains at high rates. The clearest wins: offsetting a large one-time gain, like a business sale, a property sale, or diversifying concentrated stock; and rate arbitrage, deducting at high ordinary rates today while eventually paying lower long-term gains rates.
For an investor with no gains to offset and modest income, the benefit shrinks to the $3,000 ordinary-income offset, useful, not life-changing.
Doing It Without Wrecking the Portfolio
Harvesting should never degrade the portfolio: the replacement holding must keep you diversified at your target risk. Beware harvesting into cash and waiting out the 30 days; missing a sharp rebound costs more than the tax saved. Also mind state treatment and the netting order of short-term versus long-term losses, which determines how valuable each harvested dollar is.
We run harvesting inside investment management year-round, not just in December, because losses appear on the market's schedule, not the calendar's.
Frequently Asked Questions
Can I sell at a loss and buy the identical fund back after 31 days?
Yes, that avoids the wash-sale rule, but you are out of the market for a month, and a rebound during that window can cost more than the tax benefit. Most harvesters swap immediately into a similar fund instead.
Do harvested losses expire?
No. Unused capital losses carry forward indefinitely on your federal return, offsetting future gains and $3,000 of ordinary income each year until exhausted.
Does tax-loss harvesting work in retirement accounts?
No. Gains and losses inside IRAs and 401(k)s are not taxable events, so there is nothing to harvest, and buying a harvested security inside your IRA can trigger the wash-sale rule on your taxable sale.
Tony leads Attend Wealth, a fee-based wealth management firm in Atlanta serving professionals, families, and business owners. Advisory services are held to a fiduciary standard. More about Attend
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