What Tax-Loss Harvesting Actually Does
When an investment in a taxable brokerage account drops below what you paid for it, you can sell it, lock in the loss on paper, and use that loss to offset taxes you’d otherwise owe. Up to $3,000 of net capital losses can offset ordinary income each year, and any leftover losses carry forward indefinitely to future tax years. The strategy doesn’t change your long-term portfolio; it just changes how much the IRS takes along the way.
The Wash-Sale Rule Is the Part Everyone Trips On
You can’t sell a losing fund and immediately buy back the identical fund to claim the loss. The IRS disallows the deduction if you repurchase a “substantially identical” security within 30 days before or after the sale. The workaround most people use: sell the losing fund and buy a similar-but-not-identical one in the same asset class, such as swapping one total-market index fund for a different provider’s total-market index fund. You stay invested in roughly the same exposure while the original position sits out its 30-day waiting period.
Losses Offset Gains First, Then Income
The order matters. Short-term losses offset short-term gains first, long-term losses offset long-term gains first, and only the leftover amount nets against the other category. Short-term gains are taxed at your regular income rate, so harvesting a loss to cancel out a short-term gain is usually worth more than canceling a long-term gain, which was already taxed at the lower capital gains rate.
Why December Isn’t the Only Time to Do This
Most people only think about tax-loss harvesting in December, scrambling before the calendar year closes. But markets dip all year, and a loss harvested in March is worth exactly as much as one harvested in December. Some brokerages now run automated daily tax-loss harvesting inside robo-advisor accounts, scanning for small dips and harvesting them continuously instead of waiting for one once-a-year review.
Where It Doesn’t Apply
This only works in taxable brokerage accounts. There’s no tax to harvest against inside a 401(k), traditional IRA, or Roth IRA, because those accounts already shield gains and losses from annual taxation. If most of your investing happens inside retirement accounts, tax-loss harvesting simply isn’t a lever you have access to, and that’s fine.
The Real Payoff Is Modest but Real
Tax-loss harvesting typically adds somewhere between 0.2% and 0.8% a year in tax savings for a diversified portfolio, according to research from firms like Vanguard and Betterment. It’s not going to make you rich, but it’s close to free money for anyone who already holds a taxable account and is willing to track cost basis carefully or let software do it automatically.
