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Published: August 25, 2025
Have you ever felt the sting of an underperforming investment dragging down your portfolio? But here’s the silver lining: you can turn those losses into a tax-saving strategy called tax-loss harvesting.
This clever technique allows you to offset capital gains and reduce your tax bill, all while keeping your investment strategy largely intact. In this blog post, we’ll explore the ins and outs of tax-loss harvesting, including key rules like the wash-sale rule, when to consider harvesting losses, and how this strategy can improve your after-tax returns.
Key Takeaways
- Tax-loss harvesting involves selling underperforming assets to offset capital gains and reduce your tax bill.
- Be mindful of the wash-sale rule, which prohibits repurchasing the same or substantially identical security within 30 days.
- The best times for tax-loss harvesting are typically near year-end or during market downturns.
- Unused losses can be carried forward to future years, providing ongoing tax benefits.
Understanding Tax-Loss Harvesting
Tax-loss harvesting is a strategy that involves selling investments that have decreased in value to realize a loss, which can then be used to offset gains in other investments. This not only reduces your taxable income but can also enhance your overall returns.
The concept is simple: by strategically timing when you sell certain assets, you can minimize your tax liabilities without making drastic changes to your investment portfolio.
The Wash-Sale Rule
Tax-loss harvesting can be powerful, but it comes with one big caveat: the wash-sale rule. This IRS rule determines whether you can actually claim a tax deduction for a loss. If triggered, it wipes out the benefit of harvesting by disallowing the deduction, so understanding how it works is essential before putting the strategy into practice.
What Is the Wash-Sale Rule?
One important rule to keep in mind when engaging in tax-loss harvesting is the wash‑sale rule. The IRS disallows a loss if you sell a security at a loss and repurchase the same or substantially identical one within a 30-day window before or after the sale.
What Counts as “Substantially Identical”?
The IRS doesn’t define substantially identical precisely. Instead, it depends on the facts and circumstances of each case. Generally, stocks of different companies are not substantially identical, even within the same industry. This doesn’t apply only to individual stocks ; it also covers mutual funds, exchange-traded funds (ETFs), bonds, and even options on the same or substantially identical securities (see IRS Pub 550 ↗).
Examples of the Wash-Sale Rule
- Selling shares of an S&P 500 ETF and immediately buying another ETF that tracks the exact same index (just from a different issuer) could be deemed substantially identical.
- However, selling an S&P 500 ETF and buying a Total Stock Market ETF is generally not considered substantially identical, since the holdings and exposure differ.
- Options contracts on the same stock (like calls or puts) can also trigger a wash sale if purchased within the 30-day window.
The Rule Applies Across Accounts
Another crucial point: the wash-sale rule applies across all of your accounts, not just the one where you sold the security. For example, if you sell a stock for a loss in a taxable brokerage account but then buy the same or a substantially identical stock in your IRA or 401(k) within the 30-day window, the IRS will disallow the loss. This is a common pitfall that can catch investors off guard, so it’s important to be mindful of trades across both taxable and tax-advantaged accounts.
Timing Your Harvest
Timing is everything in tax-loss harvesting. You’ll often find the best opportunities to harvest losses near the end of the year, as you review your portfolio and prepare for tax season. Market downturns are also prime times to consider this strategy, as they may present more opportunities to realize losses.
By being proactive during these periods, you can maximize the benefits of tax-loss harvesting.
Example: How Tax-Loss Harvesting Can Lower Taxable Income
Let’s walk through a simple example: Imagine you have $10,000 in capital gains from selling a winning stock. Simultaneously, you have a losing stock that has declined by $4,000. By selling the losing stock, you can offset $4,000 of your gains, thereby reducing your taxable capital gains to $6,000.
This strategy can significantly lower your tax bill, especially if you’re in a higher tax bracket.
It’s also helpful to understand the order in which the IRS applies losses. Short-term losses must first offset short-term gains, and long-term losses must first offset long-term gains. If you still have remaining losses, they can then be used to offset the other type of gain. This hierarchy matters because short-term gains are taxed at ordinary income rates, which are usually higher than long-term capital gains rates. That makes short-term losses particularly valuable to harvest.
Carrying Forward Unused Losses
What happens if your losses exceed your gains? According to IRS rules, you can use any capital losses to offset capital gains fully.
If your losses exceed your gains, you may deduct up to $3,000 ($1,500 if married filing separately) of the excess against ordinary income in the current year, with any remaining loss carried forward indefinitely to offset future gains or up to $3,000 of ordinary income each year.
For example, if you realize a $14,000 loss but have $10,000 in gains, the $10,000 gain is fully offset, leaving a $4,000 net loss. You can apply $3,000 of that against ordinary income this year ($1,500 if married filing separately), and carry forward the remaining $1,000 to the next tax year.
Additional Resources
If you’re interested in learning more about how to cut your tax bill, check out these 10 Proven Ways to Cut Your Tax Bill.
Additionally, understanding the nuances of tax-loss harvesting can be crucial, and this Charles Schwab article ↗ provides further insights into how you can reduce your tax bill through this strategy.
Tax-Loss Harvesting as Deferral, Not Elimination
While tax-loss harvesting can meaningfully reduce your tax bill in the short term, it’s important to remember that it is primarily a tax-deferral strategy, not a tax-elimination one. When you reinvest the proceeds into a replacement asset, that new holding generally carries a lower cost basis. As a result, when you eventually sell it, the taxable gain will be larger, effectively deferring the tax rather than erasing it.
The benefit is that more of your money stays invested and compounding in the meantime, which can outweigh the eventual tax liability.
Conclusion
Tax-loss harvesting is a powerful tool in the investor’s toolkit, offering a way to turn underperforming investments into tax savings. By understanding the key rules, timing your harvests effectively, and carrying forward unused losses, you can enhance your after-tax returns without disrupting your overall investment strategy.
And remember, it’s always a great idea to chat with your financial or tax advisor to make sure your decisions are right on track and aligned with the latest guidelines and laws.