Tax-Loss Harvesting Explained: Using Investment Losses to Lower Taxes
Selling investments at a loss can offset capital gains and, within limits, ordinary income. It often defers taxes rather than eliminating them. Here's how it works, the wash sale rule, and a worked example.
Tax-loss harvesting means selling an investment in a taxable account at a loss to offset taxable gains, then usually reinvesting in something similar so your market exposure continues. It's a way to make market declines produce a tax benefit.
The short version
- Realized capital losses offset capital gains.
- If losses exceed gains, up to $3,000 a year ($1,500 if married filing separately) can offset ordinary income, with the rest carried forward indefinitely.
- The wash sale rule disallows a loss if you buy substantially identical securities within 30 days before or after the sale.
- Harvesting usually defers tax, because the replacement investment has a lower cost basis.
- It only applies to taxable accounts.
A worked example
A hypothetical investor has $7,000 of long-term capital gains this year and harvests a $10,000 loss. Assume a 15% long-term capital gains rate and a 24% ordinary income rate.
Show the numbers behind this chart
| Tax saved | |
|---|---|
| Offsetting gains | $1,050 |
| Offsetting ordinary income | $720 |
Deferral, not elimination
After harvesting, you reinvest at a lower price, so your new cost basis is lower. When you eventually sell, the gain will be larger. The benefit comes from paying tax later, possibly at a lower rate, offsetting ordinary income now, or never paying it if assets are held until death and receive a basis adjustment under current law. See cost basis.
The wash sale rule
If you buy the same or a substantially identical security within 30 days before or after the sale, the loss is disallowed and added to the basis of the new shares. Purchases in IRAs and by a spouse can also trigger it. See the wash sale rule.
Common approaches:
- wait 31 days to repurchase;
- buy a similar but not identical investment to keep market exposure.
When it helps most
- You have realized gains to offset.
- You're in a high tax bracket now.
- You expect to hold investments long term or donate them.
When it may not
- Losses are small relative to transaction costs.
- You'd be in a lower bracket later anyway, or could realize gains at a 0% rate.
- It causes you to drift from your intended allocation.
The takeaway
Tax-loss harvesting turns paper losses into tax savings, mainly by deferring taxes. Watch the wash sale rule, keep your allocation on track, and get tax advice for large or complex situations.
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