When and How to Harvest Tax Losses in Your Allocation

Overview

Tax loss harvesting is a practical, tax-aware tool investors use to improve after‑tax returns and maintain portfolio exposures. Rather than holding a losing position indefinitely, investors sell depreciated holdings to realize losses that can offset realized capital gains elsewhere in the year. If losses exceed gains, up to $3,000 of the excess loss can be used to reduce ordinary income annually, and any remaining loss carries forward to future tax years (IRS Publication 550; Topic No. 409).

In my practice advising taxable account clients for more than a decade, I’ve found the most valuable outcomes come from harvesting that is integrated with portfolio allocation and rebalancing—not from chasing tax outcomes in isolation. Done thoughtfully, harvesting reduces tax drag while keeping you invested in the market.

When should you harvest losses?

• Year‑round opportunistic harvesting: Markets move constantly. If you identify an unwanted position with a meaningful unrealized loss and you can replace it with a similar exposure, harvesting mid‑year can be sensible.
• Before predictable large gains: When you know you’ll realize a large taxable gain (e.g., selling concentrated employer stock), pre‑selling some losing lots earlier in the year creates offsets.
• End‑of‑year cleanup: Many investors and advisors run a loss harvest pass in November–December to capture remaining opportunities and set carryforwards for the coming tax year, but waiting until year‑end can create a rush and missed opportunities.
• Rebalancing windows: Combine harvesting with scheduled rebalancing to avoid extra turnover and trading costs.

How tax loss harvesting works — step by step

1. Identify candidate lots. Use tax‑lot accounting to find the specific lots with the biggest tax benefit (long‑term vs short‑term). Short‑term losses offset short‑term gains first and are more valuable because short‑term gains are taxed as ordinary income.
2. Decide replacement exposure. Select a substantially similar but not “substantially identical” replacement to maintain asset allocation and avoid the wash‑sale rule (see next section). Options: different ETF tracking a similar index, a mutual fund with a similar mandate, or a broad sector ETF with slightly different holdings.
3. Execute the sale and reinvestment. Sell the losing lot, realize the loss, and reinvest into the replacement. Do not repurchase the same or substantially identical security within 30 days before or after the sale.
4. Track the tax result. Record realized losses separately by tax lot for Schedule D/Form 8949 when you file. If a wash sale applies, adjust basis of the replacement per IRS rules.

Key constraint: the IRS wash‑sale rule

The wash‑sale rule disallows a loss deduction if you buy the same or a substantially identical security within 30 days before or after the sale. The disallowed loss is not permanently lost; it is added to the basis of the replacement security and carried forward (IRS Publication 550; IRS Wash Sales guidance). In practice:

• If you sell 100 shares of Fund A at a loss, then buy the same Fund A within 30 days, the loss is disallowed and added to the basis of the new shares.
• Buying a different ETF that replicates the same index but is issued by another provider is usually acceptable, but exercise caution with funds that are economically and compositionally identical.

Always document dates and trade details — brokerage statements plus a harvesting log will make tax reporting much easier.

Practical examples (illustrative)

Example 1 — Offset a capital gain

• You sell a concentrated tech position and realize a $50,000 long‑term capital gain.
• You identify a losing biotech mutual fund with a $20,000 unrealized loss. Selling it realizes $20,000 in losses, reducing net taxable gain to $30,000.

Example 2 — Create current‑year ordinary income relief

• You have more losses than gains in 2025. After offsetting gains, you have $9,000 of excess capital losses. You can use $3,000 to offset ordinary income this year and carry forward $6,000 to future years (Topic No. 409).

These examples are simplified and omit state tax and Net Investment Income Tax (NIIT) effects — both may matter for high‑income taxpayers.

Reporting and forms

Realized gains and losses are reported on Form 8949 and summarized on Schedule D of Form 1040 (IRS instructions for Schedule D and Form 8949; Topic No. 409). If a wash sale is triggered, you must adjust your Form 8949 entry to show the disallowed loss and the adjusted basis of replacement shares.

Brokerage firms increasingly report cost basis and wash‑sale adjustments on the 1099‑B — but the taxpayer remains responsible for accurate reporting, especially for trades across multiple brokerages.

How harvesting fits into allocation and rebalancing

The most practical harvests occur when they simultaneously help maintain your target allocation:

• Use harvesting to remove losers and buy underweight assets to rebalance toward targets.
• Avoid frequent tax‑motivated trading that fragments your strategy. If you change your strategic allocation too often to chase tax outcomes, you may increase costs and behavioral risk.

If you need an allocation transition (for example, de‑risking a position), consider staged sales to spread tax consequences across years and combine with opportunistic loss harvesting.

Advanced techniques and traps

• Loss harvesting across tax lots: Preferentially sell short‑term loss lots to offset short‑term gains first. Tax‑lot accounting (FIFO, specific identification) matters—use specific identification when possible.
• Wash‑sale across accounts: The wash‑sale rule applies across IRAs and taxable accounts. Buying the same security in an IRA within the 30‑day window can disallow the loss in your taxable account without adding it to IRA basis. This is a common trap (see IRS guidance).
• Replacing with options and inverse funds: These can create complex wash‑sale and timing issues. Most DIY investors should avoid gimmicks.
• Tax‑loss harvesting and taxable bonds: Harvesting with municipal bonds, individual bonds, or cash equivalents has different implications for interest income and duration—evaluate the trade‑offs.

Tools and automation

Many robo‑advisors and wealth managers offer automated tax‑loss harvesting that monitors lots daily and executes replacements to avoid wash sales while maintaining exposures. Automation reduces paperwork and timing errors, but you still need to monitor tax reporting and the interaction with other accounts and tax events.

Common mistakes and how to avoid them

• Rebuying the same fund too quickly. Always allow 31 days if you want to repurchase the identical security.
• Ignoring short‑term loss value. Short‑term losses offset short‑term gains and ordinary income and are usually more valuable than long‑term losses.
• Poor documentation. Keep a harvesting log and download trade confirmations; brokerage 1099‑B can be incomplete across firms.
• Overfocusing on taxes. Don’t harvest losses that materially worsen your investment plan or increase concentration risk.

Practical checklist before you harvest

• Confirm the security’s tax‑lot details and holding period.
• Evaluate the economic replacement security and whether it’s substantially identical.
• Calculate the expected tax benefit: which gains will it offset, and what is the marginal tax rate? Include federal, state, and NIIT implications.
• Consider transaction costs, bid/ask spreads, and wash‑sale timing.
• Document trades and expected tax treatment.

Integration with broader tax planning

• Coordinate harvesting with other year‑end moves such as charitable giving, Roth conversions, or timing of income to manage marginal tax rates.
• Use low‑income years to realize gains and use harvested losses in other years strategically.
• Keep an eye on carryforwards: unused losses roll forward indefinitely until used.

Links and further reading

• Internal: For real‑world workflows and calendars, see our guide Year‑Round Tax‑Loss Harvesting: A Practical Workflow.
• Internal: For trading and timing nuances, see Tax‑Loss Harvesting in Practice: When to Sell, When to Hold.
• Internal: For the technical wash‑sale rules, see our glossary entry Wash‑Sale Rule.
• Authoritative: IRS Publication 550, “Investment Income and Expenses” and Topic No. 409, “Capital Gains and Losses” (irs.gov) for the official rules on wash sales, basis adjustments, and the $3,000 ordinary income limit.

Professional takeaways

In my advisory work, the best harvesting is planned, modest, and tied to portfolio objectives. It isn’t a get‑rich‑quick tax hack — it’s a bookkeeping step that can meaningfully reduce tax drag when combined with careful lot selection, attention to the wash‑sale rule, and sensible replacement choices.

Professional disclaimer: This page is educational and not personalized tax or investment advice. Tax rules change and individual circumstances vary—consult a qualified tax advisor or CPA before implementing tax‑loss harvesting strategies.