What is Tax-Loss Harvesting?
Tax-loss harvesting (TLH) is the practice of selling investments at a loss to offset capital gains and reduce your tax bill. You then immediately reinvest in similar (but not "substantially identical") securities to maintain your market exposure.
The Core Concept
If you have:
- $10,000 gain from selling Stock A
- $10,000 loss from selling Stock B
The loss offsets the gain, resulting in $0 taxable capital gains.
Why It's Valuable
- Reduce current year tax liability
- Convert short-term gains to long-term (by deferring)
- Offset up to $3,000 of ordinary income annually
- Carry forward unused losses indefinitely
How It Works
Step-by-Step Process
- Identify losses: Find positions trading below your cost basis
- Sell the losing position: Realize the loss for tax purposes
- Reinvest immediately: Buy a similar but not identical investment
- Wait 30+ days: Before repurchasing the original investment (optional)
- Record keeping: Track all transactions for tax filing
Example: ETF Tax-Loss Harvest
| Step | Action | Result |
|---|---|---|
| Original | Own $50,000 of VTI (cost basis $55,000) | $5,000 unrealized loss |
| Sell | Sell VTI for $50,000 | $5,000 realized loss |
| Reinvest | Buy $50,000 of ITOT (similar but not identical) | Stay invested in market |
| Tax benefit | $5,000 loss offsets gains | Save $750-$1,190 in taxes |
The Wash Sale Rule
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 61-Day Window
- 30 days before the sale
- Day of the sale
- 30 days after the sale
If you buy the same security within this window, the loss is disallowed.
What's "Substantially Identical"?
| Scenario | Wash Sale? |
|---|---|
| Sell VTI, buy VTI | Yes (same fund) |
| Sell VTI, buy ITOT | No (different fund, same index is gray area) |
| Sell VTI, buy VXUS | No (different index entirely) |
| Sell Apple, buy Apple | Yes (same stock) |
| Sell Apple, buy Microsoft | No (different company) |
| Sell VOO, buy IVV | Gray area (both track S&P 500) |
Safe Tax-Loss Harvesting Pairs
| Sell | Buy (Replacement) |
|---|---|
| VTI (Total Stock) | ITOT or SCHB |
| VOO (S&P 500) | IVV or SPLG |
| VEA (Developed Int'l) | IEFA or SCHF |
| VWO (Emerging Markets) | IEMG or SCHE |
| BND (Total Bond) | AGG or SCHZ |
Tax Benefits
Offsetting Capital Gains
Harvested losses first offset capital gains:
- Short-term losses offset short-term gains first
- Long-term losses offset long-term gains first
- Remaining losses offset the other type
Offsetting Ordinary Income
After offsetting all gains, up to $3,000 of losses can offset ordinary income ($1,500 if married filing separately).
Carrying Losses Forward
Unused losses carry forward indefinitely until fully used.
Tax Savings Calculation
| Scenario | Tax Rate | Savings per $10,000 Loss |
|---|---|---|
| Offset short-term gains | 22-37% | $2,200-$3,700 |
| Offset long-term gains | 15-20% | $1,500-$2,000 |
| Offset ordinary income | 22-37% | $2,200-$3,700 (up to $3k) |
Implementation Strategy
When to Harvest
- Year-end: December is common for annual tax planning
- Market downturns: Volatility creates harvesting opportunities
- Ongoing: Throughout the year as opportunities arise
Automated Tax-Loss Harvesting
Some robo-advisors offer automatic tax-loss harvesting:
- Betterment: Daily tax-loss harvesting included
- Wealthfront: Daily harvesting, stock-level for larger accounts
- Schwab Intelligent Portfolios: Automatic harvesting
DIY Tax-Loss Harvesting Checklist
- Review positions with losses monthly or quarterly
- Calculate if loss is meaningful (at least $1,000)
- Identify replacement security
- Check for wash sales in past 30 days
- Execute sell and buy on same day
- Record transaction details for taxes
- Set calendar reminder for 31 days if you want original back
When Not to Harvest
Low/No Tax Situations
- Already in 0% capital gains bracket
- Losses exceed gains plus $3,000
- Expecting much higher income in future years
Small Losses
Transaction costs and complexity may not justify harvesting losses under $500-$1,000.
Tax-Advantaged Accounts
TLH doesn't work in IRAs, 401(k)s, or other tax-advantaged accounts—there are no capital gains to offset.
Want to Keep the Position
If replacement funds have different characteristics you don't want, staying in your original position may be better.
Tax-Loss Harvesting Best Practices
- Harvest losses greater than $1,000 for meaningful benefit
- Use similar but not identical replacement funds
- Track the 30-day wash sale window carefully
- Consider tax bracket when evaluating benefit
- Keep detailed records for tax filing
- Don't let tax tail wag the investment dog
References
3- TreasuryDirect (opens in a new tab) U.S. Treasury