Tax-Loss Harvesting

Tax loss harvesting means selling investments that have fallen in value to realise a capital loss, then using that loss to offset taxable gains or a limited amount of other income. To stay invested, the investor buys a similar, but not substantially identical, investment. Done well, it can lower taxes in the current year and, over time, defer taxes and let more money compound. It is mainly relevant for taxable accounts, and the details depend on each country's rules. This lesson focuses on the US and is educational, not tax advice.

How it works#

1. Identify positions with unrealised losses in a taxable account.
2. Sell them to realise the losses.
3. Buy a similar investment to keep market exposure, avoiding substantially identical securities. See Wash Sale Rule.
4. Use the losses to offset capital gains, then up to $3,000 of ordinary income per year, carrying any remainder forward.
5. Optionally switch back after 31 days.

The real benefit#

The benefit is largest for investors in high tax brackets with realised gains, and it is zero in tax advantaged accounts such as IRAs and 401(k)s.

Choosing replacement investments#

Whether funds tracking the same index from different issuers are substantially identical is unclear; many advisers avoid such swaps.

Common mistakes#

1. Triggering wash sales through purchases in other accounts, including IRAs or dividend reinvestment.
2. Letting the tax tail wag the dog, making poor investment decisions to save tax.
3. Ignoring transaction costs and spreads.
4. Forgetting the lower cost basis, which raises future taxable gains.
5. Harvesting tiny losses that are not worth the effort or tracking.

Harvesting for traders#

Active traders often realise losses naturally through trading, but should watch wash sales across frequently traded stocks, especially near year end. Futures traders face different rules, since Section 1256 contracts are marked to market each year. See Trading Taxes and Capital Gains.

Automated harvesting#

Many robo advisers and direct indexing services harvest losses automatically by owning individual stocks and swapping losers for similar ones. Their benefit depends on tax rates, market volatility and future plans for the money. See Active vs Passive Investing.

Other countries#

In the UK, gains and losses on assets outside ISAs and pensions can offset each other for capital gains tax, but share matching rules treat repurchases within 30 days similarly to wash sales, a practice known as bed and breakfasting. Other countries have their own rules.

Frequently asked questions#

What is tax loss harvesting?#

Selling investments at a loss to offset capital gains or some ordinary income, while buying similar investments to stay invested.

Does tax loss harvesting really save money?#

It can lower current taxes and defer future ones, with the largest benefit for high tax brackets, but much of the gain comes from deferral rather than permanent savings.

Can I harvest losses in an IRA?#

No benefit applies in tax advantaged accounts, and purchases in an IRA can trigger wash sales on losses in taxable accounts.

Next, learn what records every trader should keep in Record Keeping for Traders.