Quick overview

Tax-loss harvesting is a targeted, tax-aware trading technique used in taxable brokerage accounts to reduce a taxpayer’s current-year capital gains and, in some cases, ordinary income. The basic idea: sell investments that have lost value to create realized losses, use those losses to offset realized gains elsewhere in the year, and then reinvest in similar (but not “substantially identical”) securities to stay invested in the market.

This strategy is most useful for investors who hold taxable (non-retirement) accounts and who face realized capital gains in the year, but it can be employed year-round — not just at year-end — to capture losses as they occur.

Why tax-loss harvesting matters

  • Realized losses offset realized gains one-for-one for tax purposes, lowering taxable capital gains for the year (IRS netting rules apply).
  • If net capital losses remain after offsetting gains, up to $3,000 ($1,500 if married filing separately) can be deducted against ordinary income per year; the remainder carries forward indefinitely (IRS guidance).
  • Harvesting helps improve after-tax returns over time, especially for investors in higher tax brackets or with concentrated gains.

(Source: IRS Publication 550 and IRS guidance on capital gains.)

How the mechanics work — step by step

  1. Identify candidate positions: look for individual securities or tax lots with unrealized losses in your taxable account. Prioritize tax lots where selling creates the most tax efficiency (short-term losses can offset short-term gains, which are taxed at higher ordinary rates).

  2. Realize the loss: sell the identified lot and record the date, proceeds, and cost basis. The realized loss now exists for tax netting.

  3. Replace exposure: immediately or soon after selling, buy a different security that provides similar market exposure but is not “substantially identical.” For example, sell an S&P 500 ETF and buy a total U.S. stock ETF, or sell a single large-cap tech stock and buy a diversified tech sector ETF. This keeps you invested while avoiding a wash-sale.

  4. Track the wash-sale window: do not buy substantially identical securities within 30 days before or after the sale (a 61-day window around the sale date) if you intend to claim the loss. If you do repurchase a substantially identical security within that period, the loss is disallowed and typically added to the basis of the replacement position (IRS Pub. 550) — a common and costly mistake.

  5. Report correctly: when filing taxes, report realized gains and losses on Form 8949 and Schedule D; integrate any carryforward losses from prior years.

Notes on tax-lot selection: choose which specific lots to sell (if your broker supports specific identification) instead of default FIFO to control whether gains/losses are short-term or long-term.

Wash-sale rule: the single biggest operational risk

The wash-sale rule disallows a tax deduction for a loss if you purchase a “substantially identical” security within 30 days before or after the sale. This rule applies across all of your accounts — including IRAs and accounts you control — so buying the same or substantially identical security in an IRA within 30 days can permanently disallow the loss (IRS Pub. 550). For a plain-language primer on this rule and edge cases, see our glossary entry on the [Wash-Sale Rule](