Tax-loss harvesting is the practice of selling an investment that has declined in value to “realize” the loss for tax purposes. You then use that loss to offset capital gains you’ve earned elsewhere in your portfolio. If your losses exceed your gains, you can use up to $3,000 of the excess to reduce ordinary income each year, and any remaining losses carry forward to future tax years indefinitely.
You’re not trying to lose money on net. You sell one holding and replace it with something similar, keeping your market exposure roughly the same. The tax savings are the point.
How it actually works
Say you own two funds in a taxable brokerage account:
| Holding | Purchase price | Current value | Gain / Loss |
|---|---|---|---|
| S&P 500 index fund | $10,000 | $13,500 | +$3,500 gain |
| International stock fund | $8,000 | $6,200 | -$1,800 loss |
During the year, you sell the S&P 500 fund and realize a $3,500 capital gain. Without harvesting, you’d owe tax on that full $3,500.
Now suppose you also sell the international fund and realize the $1,800 loss. Your net taxable gain drops to $1,700 ($3,500 minus $1,800). If you’re in the 15% long-term capital gains bracket, that’s $270 less in taxes owed this year.
After selling, you buy a different international stock fund (say, one tracking a slightly different index) to maintain your market exposure. You’ve stayed invested while capturing the tax benefit.
The wash sale rule is the critical constraint
The IRS wash sale rule prevents you from claiming a loss if you buy a “substantially identical” security within 30 days before or after the sale. The window is 61 days total, 30 days before the sale, the day of the sale, and 30 days after.
If you trigger a wash sale, the loss is disallowed. It doesn’t disappear permanently, it gets added to the cost basis of the replacement shares, deferring the benefit until you eventually sell. But you’ve lost the immediate tax advantage you were trying to capture.
The practical workaround: replace a sold fund with a similar but not identical one. Selling a Vanguard S&P 500 ETF and immediately buying a Fidelity S&P 500 ETF would likely be considered substantially identical. Selling an S&P 500 fund and buying a total US stock market fund is generally considered acceptable. The IRS hasn’t published a precise definition, so conservative investors give themselves more distance, swapping an S&P 500 fund for a total market or a large-cap value fund rather than a near-identical product.
The wash sale rule also applies across accounts. If you sell a fund at a loss in a taxable account and your spouse buys the same fund in their IRA during the 61-day window, the wash sale rule applies.
What losses can offset
Capital losses offset capital gains first, like-for-like where possible (short-term losses against short-term gains, long-term against long-term). Once gains are fully offset, excess losses can offset up to $3,000 of ordinary income per year for single filers and married filing jointly.
If you harvest $15,000 in losses in a year where you have $8,000 in gains, you eliminate the $8,000 gain entirely and deduct $3,000 from ordinary income. The remaining $4,000 carries forward to next year.
Short-term capital gains (assets held less than one year) are taxed at ordinary income rates, which can reach 37%. Long-term capital gains (held more than one year) are taxed at 0%, 15%, or 20% depending on income. Harvesting losses to offset short-term gains delivers the biggest tax savings.
The net investment income tax adds another layer
If your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly), you may owe an additional 3.8% net investment income tax on investment income including capital gains. Tax-loss harvesting reduces the gains subject to this surcharge as well, which increases the value of harvesting for higher-income investors.
Where harvesting works and where it doesn’t
Tax-loss harvesting only applies to taxable brokerage accounts. Losses inside an IRA, Roth IRA, or 401(k) have no tax consequence at all since those accounts are already tax-advantaged. You can’t harvest losses from a retirement account.
The strategy is most valuable when you have substantial capital gains to offset, when your marginal tax rate on gains is high, or when you’re in a volatile market where short-term dips create harvesting opportunities. For someone in the 0% capital gains bracket (taxable income below approximately $47,025 for single filers in 2025), harvesting matters less because gains already incur no tax.
There’s also a timing dimension. Harvesting a loss defers the tax, it doesn’t permanently eliminate it. When you eventually sell the replacement fund at a gain, that gain may be larger (since your cost basis is now lower). Whether this is a net positive depends on how your tax rate changes over time and how long you hold the replacement.
How to use this in practice
Most major brokerages (Fidelity, Vanguard, Schwab) show unrealized gains and losses in your taxable accounts. In late November or December, review any positions sitting at a meaningful loss, especially if you’ve also realized gains during the year.
Before selling, confirm the replacement fund you’ll buy is sufficiently different from the one you’re selling, and wait at least 31 days before considering buying back the original. Track the lot carefully, you’ll need the cost basis and sale price when you file your taxes.
Keep records. Your brokerage will send a Form 1099-B at year-end showing proceeds and cost basis for each sale. This feeds directly into Schedule D on your tax return.
If you use a robo-advisor, many of them (Betterment, Wealthfront, Schwab Intelligent Portfolios Premium) perform tax-loss harvesting automatically on your behalf, monitoring positions daily and swapping funds as opportunities arise. This automated approach tends to capture more frequent small losses than manual year-end reviews.