How do harvesting strategies work in low-tax-loss years?
Tax-loss harvesting in a low-tax-loss year focuses on getting the most tax benefit from a small pool of losses. Instead of waiting for a large market drawdown, you prioritize which losses to capture, how to replace exposures without triggering the wash-sale rule, and whether to pair harvesting with other moves like targeted capital-gain realization or a Roth conversion in a low-income year. This article explains practical tactics, record‑keeping, and traps to avoid, with links to deeper FinHelp guides.
Why low-tax-loss years require a plan
When your taxable accounts show only modest unrealized losses, every dollar of loss becomes more valuable because it can only be used once to offset gains or up to $3,000 ($1,500 if married filing separately) of ordinary income per year, with unused losses carried forward indefinitely (IRS, Topic No. 409; Publication 550). That scarcity changes how you should act: small losses are worth more to offset short-term or high-tax-rate gains, to move income between years, or to enable tax-aware rebalancing.
Source references: IRS Topic No. 409, Capital Gains and Losses (https://www.irs.gov/taxtopics/tc409) and IRS Publication 550, Investment Income and Expenses.
Core tactics for low-tax-loss years
- Prioritize which losses to capture
- Target losses that offset the highest-taxed gains first: short‑term gains (taxed as ordinary income) and gains taxed at your highest capital‑gains rate. Use cost‑basis and tax‑lot reports to identify small lots with losses.
- In my practice, clients often undervalue small short-term loss lots; harvesting a few of these can cut a meaningful chunk of a year’s tax bill.
- Use specific identification when selling
- Direct your broker to sell specific tax lots (not FIFO) so you can choose the ones that create the loss you need. This allows precise harvesting while keeping other lots with lower or no realized loss.
- Avoid the wash-sale rule
- The wash-sale rule disallows a loss if you buy the same or a substantially identical security within 30 days before or after the sale (a 61‑day window that includes the sale date). To keep your market exposure while claiming the loss:
- Buy a similar-but-not‑substantially‑identical ETF or fund, or
- Wait 31+ days, or
- Use tax‑efficient alternatives (for example, swap between non‑identical ETFs that track similar exposures).
- Note: wash sales also apply across accounts, including IRAs. If you sell a stock at a loss in a taxable account and your IRA buys the same security within the window, the loss may be disallowed (IRS Publication 550).
- Consider tax‑gain harvesting as a companion strategy
- In years with low ordinary income or low capital‑gains rates, realize small gains intentionally to use available low‑rate windows and reset cost basis. This can pair well with small losses to smooth taxable outcomes across years. See our guide on Roth conversion timing for coordinating low‑income years: Roth Conversion Strategies for Low-Income Years.
- Use replacements to stay invested
- Capture the tax loss but maintain exposure with a different security that fills the same role. For example, swap an S&P 500 mutual fund for a broad large‑cap ETF that is not substantially identical. This preserves your investment plan while creating the tax benefit.
- Think in windows, not single dates
- Harvesting can occur year‑round, not only at year‑end. Revisit holdings after market swings. For mid‑year declines, opportunistic harvesting may produce better outcomes than waiting until December. Our article on ongoing harvesting discusses this: Using Tax-Loss Harvesting Beyond Year-End.
Practical examples (numbers simplified)
Example A — Offset a large short‑term gain
- Realized short‑term gain this year: $20,000 (taxed as ordinary income).
- Available taxable account losses you can harvest: $7,000.
- Net taxable short‑term gain: $13,000.
- Result: Harvesting reduces the high‑tax short‑term gain first, which is generally the most beneficial outcome.
Example B — No large gains, preserve future offsets
- Realized gains this year: $0.
- Harvested losses: $4,000.
- You may use $3,000 to offset ordinary income this year and carry forward $1,000 to future years. Carryforwards are indefinite and apply first against capital gains in future years (IRS, Topic No. 409).
Example C — Coordinating with a Roth conversion
- Low ordinary income year: consider realizing some gains or harvesting small losses and converting traditional IRA money to Roth while you’re in a lower bracket. Coordinate with your tax advisor and review our Roth conversion guide above.
Tax reporting and documentation
- Report sales on Form 8949 and Schedule D; your broker will issue Form 1099‑B with cost basis and wash‑sale adjustments when applicable (IRS instructions for Form 8949). Keep records of trade confirmations, replacement purchases, and dates to prove compliance with the wash‑sale rule.
- Use tax‑lot software or broker cost‑basis tools to track specific identification dispositions. Accurate record‑keeping reduces the risk of IRS adjustments and audit friction.
Common pitfalls and how to avoid them
- Ignoring cross‑account wash sales: a repurchase in an IRA or spouse’s account can disallow a loss. Check trades across all accounts you control.
- Chasing tax outcomes over investment sense: don’t sell a core holding solely for a small tax benefit if it violates your long‑term allocation or costs you expected future returns.
- Overtrading and transaction costs: frequent harvesting in taxable accounts can increase commissions, bid‑ask slippage, and tracking error. Model net benefits before acting.
- Misunderstanding “substantially identical”: the IRS does not define this precisely. Avoid repurchasing the same ticker or identical mutual fund share class within the wash‑sale window.
When harvesting might not be worth it
- Small losses after trading costs and bid‑ask spreads may offer little net tax benefit.
- If capturing a loss forces you to abandon a long‑term strategy (for example selling a long‑held concentration), the tradeoff could be unfavorable.
- If you expect a big loss next year and already have modest carryforwards, you might defer harvesting until you can use larger losses more efficiently.
A short action checklist for the next 90 days
- Pull a tax‑lot report from your broker and sort lots by unrealized loss and short‑term vs. long‑term holding period.
- Identify losses that offset short‑term gains first and long‑term gains second.
- Plan replacement securities that are not substantially identical to avoid wash‑sale issues.
- Use specific‑identification instructions when placing sell orders.
- Log trade confirmations and update your tax worksheet (or ask your tax preparer to do so).
- Reassess in December for any year‑end adjustments.
Interlinked FinHelp resources
- For a general primer: Tax-Loss Harvesting
- For timing beyond year‑end: Using Tax-Loss Harvesting Beyond Year-End
- To compare strategies: Capital Gains Harvesting vs. Tax-Loss Harvesting
Authoritative sources and further reading
- IRS — Topic No. 409, Capital Gains and Losses: https://www.irs.gov/taxtopics/tc409
- IRS — Publication 550, Investment Income and Expenses
- IRS — Instructions for Form 8949 and Schedule D (sales and dispositions reporting)
- Consumer Financial Protection Bureau — materials on capital gains and taxes
Professional note and disclaimer
In my practice, disciplined use of small losses during otherwise low‑loss years often produces outsized tax efficiency without disrupting long‑term plans. That said, every situation is unique: this article is educational and not individualized tax advice. Consult a qualified tax advisor or CPA before implementing harvesting strategies that materially change your portfolio or tax position.
(Updated 2025 — facts and IRS references reviewed.)
