The Strategy

Making the Most of Market Volatility

Tax-loss harvesting is the silver lining of market downturns. It allows you to sell an investment that has declined in value, realize the loss, and use that loss to reduce your tax bill.

Offset Gains

Capital Gains Offset

Realized losses first offset realized capital gains of the same type (short-term vs. short-term, long-term vs. long-term). This can reduce your 15% or 20% capital gains tax to zero.

$3,000

Income Deduction

If your losses exceed your gains, you can use up to $3,000 of excess loss to offset ordinary income (like your salary), saving you tax at your highest marginal rate.

Indefinite

Carryforward

If you have more than $3,000 in excess losses, you don't lose them. They "carry forward" to future tax years indefinitely until they are fully used up.

Wash-Sale

The 30-Day Rule

To claim the loss, you must avoid buying the same or a "substantially identical" security within 30 days before or after the sale.

Execution

How to Execute Tax-Loss Harvesting

The goal is to realize the tax benefit without changing your portfolio's long-term risk and return profile. The process follows these steps:

  1. Identify: Look for positions in your taxable brokerage account that are currently worth less than you paid for them (unrealized losses).
  2. Sell: Sell the losing position to "realize" the loss for tax purposes.
  3. Replace: Immediately buy a similar but not identical investment to maintain your market exposure. For example, sell an S&P 500 ETF and buy a Total Stock Market ETF.
  4. Wait: Wait at least 31 days before switching back to the original investment if you prefer it, to avoid the wash-sale rule.

The IRS Rule

Understanding the Wash-Sale Rule

The IRS created the wash-sale rule to prevent taxpayers from selling a security just to claim a tax loss and then immediately buying it back. A wash sale occurs if you sell a security at a loss and, within 30 days before or after the sale, you:

  • Buy the same security
  • Buy a "substantially identical" security
  • Acquire a contract or option to buy the security
  • Buy the security in a retirement account (like an IRA or 401k)

⚠️ The IRA Trap: If you sell a stock at a loss in your taxable account and buy it back within 30 days in your IRA, the loss is permanently disallowed, and you cannot even add the loss to the basis of the IRA shares.

ActionResultReason
Sell S&P 500 ETF (Vanguard) and buy S&P 500 ETF (iShares)Potential Wash SaleMost experts consider ETFs tracking the same index to be "substantially identical."
Sell S&P 500 ETF and buy Total Stock Market ETFSafeThese track different indices and have different constituent stocks.
Sell individual Tech stock and buy Technology Sector ETFSafeReplacing a single stock with a diversified fund is not a wash sale.

Advanced Strategies

Advanced Harvesting Strategies

  • Harvesting in Down Markets: Don't wait until December. High-volatility months (like March 2020 or throughout 2022) provide the best opportunities to "bank" losses that can offset gains for years to come.
  • Asset Location: Tax-loss harvesting only works in taxable brokerage accounts. It does not apply to IRAs, 401(k)s, or 403(b)s because those accounts are already tax-advantaged.
  • Specific ID Cost Basis: When selling, use the "Specific Identification" method rather than "Average Cost." This allows you to pick exactly which shares (the ones with the highest cost basis) to sell to maximize your realized loss.
  • Avoid Reinvesting Dividends: If you're planning to harvest a loss, turn off automatic dividend reinvestment for that security. A reinvested dividend is technically a "purchase" and could trigger a partial wash sale.

FAQ

Frequently Asked Questions

No. Tax-loss harvesting only provides a tax benefit in taxable brokerage accounts. Gains and losses inside tax-deferred accounts (like a Traditional IRA or 401k) or tax-free accounts (like a Roth IRA) have no immediate tax impact.

The IRS has never provided a precise definition. However, it generally means securities that are not significantly different in risk and return. Selling one company's stock and buying another in the same industry is usually fine. Selling one S&P 500 fund and buying another from a different provider is likely a wash sale.

You can use realized capital losses to offset an unlimited amount of capital gains. If your losses exceed your gains, you can use up to $3,000 per year ($1,500 if married filing separately) to offset ordinary income like your salary. Any remaining loss is carried forward to future years.

Not necessarily. It's essentially a tax deferral strategy. By realizing a loss and buying a similar security, you lower your cost basis. This means you'll owe more tax when you eventually sell the new security at a profit. It's most beneficial if you are in a higher tax bracket now than you expect to be in the future.

Sources
  • IRS Publication 550 — Investment Income and Expenses
  • IRS Topic No. 409 — Capital Gains and Losses
  • Internal Revenue Code Section 1091 — Loss from wash sales of stock or securities
  • Plootus Research — April 2026