Overview
Capital loss harvesting—often called tax‑loss harvesting—is the deliberate realization of investment losses inside taxable accounts to offset realized capital gains and, to a limited extent, ordinary income. When you sell a security for less than your cost basis, that loss can reduce taxes you owe on gains elsewhere in the year or be carried forward to future years. The strategy is commonly used by taxable investors who want to control the timing and size of their tax bills while maintaining a sensible long‑term investment plan (IRS, Tax Topic 409).
This article explains when loss harvesting makes sense, how to do it without tripping over the IRS wash‑sale rule, ways to reinvest proceeds, tax reporting basics, and common pitfalls I see in practice.
Sources referenced throughout include IRS guidance (Tax Topic 409 and Publication 550) and practical best practices developed in advisory work.
When does harvesting losses make sense?
- You have realized capital gains in the tax year. Harvested losses are most valuable when they offset gains taxed at higher rates or on large, one‑time gains (e.g., sale of business stock or an inherited asset sale).
- You expect near‑term capital gains and want to smooth taxable income across years.
- You hold taxable (non‑retirement) accounts with underperforming positions that are not core to your long‑term allocation.
- You want to rebalance without realizing net taxable gains.
In my advisory practice, harvesting is especially useful at year‑end for clients with lumpsum gains, and during down markets when investors naturally have more paper losses to work with.
How to harvest losses—step‑by‑step
- Inventory taxable accounts: list positions with unrealized losses, their cost bases, and holding periods (short vs. long term).
- Match losses to gains: sell losing positions to offset realized gains. Long‑term losses offset long‑term gains first, then short‑term, and vice versa when netting—follow IRS guidance when preparing Schedule D and Form 8949.
- Reinvest carefully: avoid buying the same or a “substantially identical” security within 30 days before or after the sale (wash‑sale rule). Consider buying a different ETF or mutual fund that tracks a similar exposure but isn’t substantially identical.
- Use excess loss allowance: if losses exceed gains, you can deduct up to $3,000 against ordinary income ($1,500 if married filing separately) and carry forward remaining losses indefinitely (IRS Tax Topic 409).
- Document everything: retain trade confirmations and notes on rationale—helpful if the IRS questions the timing or the wash‑sale rule.
The wash‑sale rule—what to avoid
The wash‑sale rule disallows a loss if you (or your spouse or a company you control) buy the same or a substantially identical security within 30 days before or after the sale. The rule also applies if a loss is generated in an IRA and you still own the security in the IRA—losses in that scenario can be permanently disallowed.
Practical workarounds:
- Buy a non‑identical but correlated ETF or mutual fund to maintain market exposure (for example, swap a single stock for a broad sector ETF).
- Use tax‑aware rebalancing: move the replaced security to a tax‑advantaged account if you plan to re‑buy it sooner.
- Wait 31 days to re‑purchase the identical security if maintaining the wash‑sale bright line is critical.
For detailed IRS guidance on wash sales and reporting, see Publication 550 (Investment Income and Expenses) and the IRS website. The wash‑sale logic is rooted in IRC Section 1091 and practical guidance in IRS Pub 550.
Reinvesting after a loss—options that work
- Buy a similar but not substantially identical ETF or mutual fund to preserve exposure while avoiding wash‑sale risk.
- Reallocate proceeds into cash or bonds temporarily if you need a tactical pause.
- Harvest losses as part of a larger rebalance—replace a losing position with a diversified holding aligned to your target allocation.
Example: If you sell a U.S. large‑cap ETF at a loss, you might buy an ETF that tracks a different large‑cap index, a broad U.S. total‑market ETF, or a sector ETF that keeps economic exposure but avoids “substantially identical” classification.
Tax reporting—forms and simple rules
- Report sales on Form 8949 and summarize on Schedule D of Form 1040. Brokerage firms typically provide Form 1099‑B showing proceeds and cost basis; you must reconcile those figures for accurate filing.
- Net gains and losses: short‑term and long‑term categories are calculated separately, then netted together to determine taxable capital gain or deductible loss.
- Excess capital losses: you can deduct up to $3,000 ($1,500 if married filing separately) against ordinary income per year; unused amounts carry forward without a time limit (IRS, Tax Topic 409).
If your brokerage reports adjustments for wash sales on Form 1099‑B, include those adjustments on Form 8949.
Special cases and investments
- Mutual funds and ETFs: wash‑sale rules still apply. When replacing a fund, ensure the substitute isn’t “substantially identical.” If you hold the same fund in another account, selling at a loss could still trigger a wash sale.
- Options, convertible securities, and swaps: these can create complicated tax outcomes. Check IRS guidance and consult a tax pro if you use derivatives.
- Real estate losses: losses on personal residences are not deductible, but losses from sales of investment real estate flow through capital loss rules or may be reported under passive activity rules.
Tax‑planning strategies and tradeoffs
- Loss harvesting vs. selling for fundamentals: Don’t let taxes drive poor investment choices. Use harvesting to accelerate tax benefits on decisions you already planned for because of the investment’s outlook.
- Timing with Roth conversions: Harvested losses reduce taxable income in a year, which can help manage tax brackets if you’re doing a Roth conversion. Coordinate with your tax advisor to balance gains from conversion and harvested losses.
- Donation alternative: Instead of harvesting losses, donating appreciated securities to charity can avoid capital gains tax on the donated shares and provide a charitable deduction. Compare the tax math before deciding.
Common mistakes and how to avoid them
- Triggering a wash sale by repurchasing too quickly or holding the replacement in another account.
- Harvesting losses on highly concentrated positions without a plan to reduce concentration risk.
- Letting tax deferral override sound portfolio construction—tax savings won’t justify holding a poor investment indefinitely.
- Forgetting to adjust cost basis when a wash‑sale disallows a loss—wash sale disallowed amounts are added to the basis of the repurchased security.
Example scenario (simple math)
- You bought Stock A for $10,000; it is now worth $7,000—an unrealized loss of $3,000.
- You also sold Stock B this year for a $4,000 gain. By selling Stock A, you realize a $3,000 loss that nets against the $4,000 gain, leaving $1,000 net taxable gain.
- If you had no other gains, a $3,000 realized loss would offset up to $3,000 of ordinary income this year and carry forward remaining losses.
This example illustrates tax mechanics, not an investment recommendation.
Year‑end checklist for loss harvesting
- Review unrealized losses and realized gains year‑to‑date.
- Confirm holdings across all accounts (taxable and IRAs) to avoid unintentional wash sales.
- Check Form 1099‑B early in the year for accurate cost‑basis reporting from brokers.
- Coordinate with your CPA or tax advisor before executing large transactions late in the year.
Interlinked resources on FinHelp
- For readers comparing similar strategies, see our piece on Capital Gains Harvesting vs. Tax‑Loss Harvesting which explains when to harvest gains versus losses.
- If you have a major life event that will change your tax picture, read Timing Capital Gains Around Major Life Events: A Practical Guide to plan when to realize gains or losses.
Final professional tips
- Be proactive year‑round; waiting until December can lead to rushed, emotionally driven decisions.
- Keep clear notes and records for every harvested position—tax seasons and audits reward good documentation.
- Work with a tax professional when transactions are large, involve complex securities, or interact with retirement accounts.
FAQ (brief)
- Can losses from any taxable investment be harvested? Yes—stocks, bonds, ETFs, and most taxable mutual funds can generate capital losses for tax purposes. Certain assets (like personal residences) are excluded or treated differently.
- How long before I can buy back a security? Avoid buying the same or substantially identical security for 30 days after the sale; many investors wait 31 days to be safe.
- Is there a limit on how much loss I can claim? There’s no limit on losses used to offset gains, but you can only deduct $3,000 of net capital loss against ordinary income each tax year; excess loss carries forward (IRS Tax Topic 409).
Professional disclaimer
This article is educational and general in nature and does not constitute individualized tax or investment advice. Tax rules are complex and facts change; consult a qualified tax professional or financial advisor before implementing any tax‑loss harvesting strategy.
Authoritative sources
- IRS, Tax Topic 409: Capital Gains and Losses: https://www.irs.gov/taxtopics/tc409
- IRS Publication 550, Investment Income and Expenses (wash sales and reporting): https://www.irs.gov/publications/p550
- IRS, About Schedule D (Form 1040), Capital Gains and Losses: https://www.irs.gov/forms-pubs/about-schedule-d-form-1040
(Information current as of 2025.)
