# Tax-Loss Harvesting

> Tax loss harvesting sells investments at a loss to offset gains while keeping similar exposure. Learn how it works, its real benefit and common mistakes.

Source: https://learn.tradelabsai.com/industry/tax-loss-harvesting/  
Track: The Trading Industry · Level: Beginner · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "Tax-Loss Harvesting", https://learn.tradelabsai.com/industry/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](https://learn.tradelabsai.com/industry/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.

**Example: Harvesting a loss in a market dip**
An investor holds $40,000 of an S&P 500 index fund bought for $50,000, a $10,000 unrealised loss. Earlier in the year, they realised $6,000 of short term gains. They sell the fund, realising the $10,000 loss, and immediately buy a total US stock market fund, which is similar but tracks a different index. The loss offsets the $6,000 of gains, then $3,000 of ordinary income, and $1,000 carries forward. At a 32% tax rate on short term gains and income, the immediate saving is about $2,880 (32% of $9,000). The new fund's lower cost basis means more tax may be due when it is eventually sold, so much of the benefit is deferral.

## The real benefit

| Benefit | Explanation |
|---|---|
| Rate arbitrage | Losses offsetting short term gains (high rate) while future gains may be long term (lower rate) |
| Deferral | Paying tax later lets the money compound in the meantime |
| Offsetting income | Up to $3,000 a year against ordinary income |
| Step up at death (US) | Inherited assets may receive a new cost basis, potentially eliminating deferred gains |

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

| Original | Possible replacement |
|---|---|
| S&P 500 index fund | Total US market fund or a large cap fund tracking a different index |
| Individual tech stock | A technology sector ETF |
| International index fund | An international fund tracking a different index |

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](https://learn.tradelabsai.com/industry/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](https://learn.tradelabsai.com/portfolio/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](https://learn.tradelabsai.com/industry/record-keeping-for-traders/).

## Continue learning

- Next lesson: [Record Keeping for Traders](https://learn.tradelabsai.com/industry/record-keeping-for-traders/)
- Previous lesson: [Wash Sale Rule](https://learn.tradelabsai.com/industry/wash-sale-rule/)
- Related: [Wash Sale Rule](https://learn.tradelabsai.com/industry/wash-sale-rule/): The US wash sale rule disallows a loss if you buy the same or a substantially identical security within 30 days. Learn how it works, cost basis effects and traps.
- Related: [Trading Taxes and Capital Gains](https://learn.tradelabsai.com/industry/trading-taxes-and-capital-gains/): An overview of how trading profits are taxed: short and long term capital gains, futures 60/40 treatment, crypto, losses, trader tax status and UK basics.
- Related: [Rebalancing](https://learn.tradelabsai.com/portfolio/rebalancing/): Rebalancing brings a portfolio back to its target weights after markets move. Learn calendar and threshold rebalancing, costs, taxes and the rebalancing premium.
- Related: [Record Keeping for Traders](https://learn.tradelabsai.com/industry/record-keeping-for-traders/): Good records protect traders at tax time, in disputes and in self review. Learn what to record for every trade, how long to keep records and simple systems.
- Related: [Active vs Passive Investing](https://learn.tradelabsai.com/portfolio/active-vs-passive-investing/): Active investing tries to beat the market; passive investing tracks it at low cost. Learn the evidence on performance, the impact of fees and how to choose.