What tax-loss harvesting is
Tax-loss harvesting means selling an investment that is worth less than you paid for it in a taxable brokerage account, so that the loss offsets capital gains or income. The loss does not make you money by itself: you still own less than you paid. What it does is reduce your tax bill now, and often replace the sold holding with a similar one so your portfolio stays invested. It is a way of moving tax from this year to a later year, and it is most useful when you have gains to offset or you expect to be in a lower bracket when you eventually sell the replacement.
How losses are netted
The tax code applies a fixed order. Short-term losses first offset short-term gains and long-term losses offset long-term gains. If one group ends in a loss and the other in a gain, they offset each other. The remaining net loss can reduce ordinary income by up to $3,000 a year ($1,500 for married filing separately), and any excess carries forward to future years with no expiration. Short-term gains are taxed at ordinary rates up to 37%, long-term gains at 0%, 15% or 20%, so a short-term loss that wipes out a short-term gain is worth more than a long-term loss that wipes out a long-term gain.
Examples
- Offset a gain. A single filer with $100,000 of other taxable income has a $10,000 long-term gain and sells a long-term loser for a $10,000 loss. The gain is erased and federal tax falls by $1,500 (15% of $10,000).
- Offset income. With no gains, a $10,000 loss deducts $3,000 against ordinary income, saving $660 at a 22% bracket, and carries $7,000 to next year.
- Short-term loss against mixed gains. The same filer with an $8,000 short-term gain and a $10,000 long-term gain who harvests a $10,000 short-term loss ends up with only $8,000 of long-term gain, saving about $2,106.
The wash-sale rule
Section 1091 of the Internal Revenue Code disallows a loss if you buy the same stock or securities, or substantially identical ones, within 30 days before or after the sale, a 61-day window. The rule also applies if your spouse or an IRA you control buys the shares. The disallowed loss is added to the cost basis of the new shares, so it is deferred rather than lost. To stay invested, many investors buy a similar but not identical fund, for example one tracking a different index. Whether two funds are “substantially identical” is a judgement the IRS has not defined by a bright-line test, so be conservative.
Is it worth it?
Harvesting is worth the most when the gain you offset would be taxed at 15% or 20% and when you can reinvest without meaningful trading costs. It is worth little when your gains would be taxed at 0%, in a retirement account, or in a year when you expect your tax rate to be much higher later. Lower basis on the replacement means a larger gain at a later sale, so the benefit is often a deferral. Also avoid selling just for the tax: a bad investment decision costs more than a tax saving. See our tax-loss harvesting guide for a full walk-through, including the end-of-year trading calendar.