Tax-Loss Harvesting: How to Turn Losing Investments Into a Tax Break

Every year, investors with gains in their taxable accounts get a tax bill. Tax-loss harvesting is the legal strategy of selling investments at a loss to offset those gains — reducing what you owe without changing your overall market exposure. Done right, it can save thousands per year.

The IRS allows this. It's not a loophole — it's how the tax code is written.

How It Works

Step 1: You have Investment A that's up $12,000 (unrealized gain). You're considering selling.

Step 2: You also hold Investment B, which is down $5,000 from your purchase price.

Step 3: Sell Investment B. You realize the $5,000 loss.

Step 4: Your net taxable gain drops from $12,000 to $7,000.

Step 5: Immediately buy a similar (but not identical) investment to maintain your market exposure.

At 15% long-term capital gains rate, harvesting that $5,000 loss saves you $750. The money stays invested — you've just swapped one fund for a similar one.

The Wash Sale Rule

You cannot buy back the same security within 30 days before or after the sale. If you do, the loss is disallowed.

What triggers wash sale: Selling VTI at a loss and buying VTI back within 30 days.

What doesn't: Selling VTI and immediately buying SCHB (a different ETF tracking a similar but different index). Different ticker, different fund — not a wash sale.

This is why having substitute funds identified before you harvest matters. Common pairs:

• VTI (Vanguard Total Market) ↔ SCHB (Schwab Broad Market)
• VXUS (Vanguard International) ↔ IXUS (iShares International)
• BND (Vanguard Bonds) ↔ AGG (iShares Bonds)

Using Losses Beyond Gains

If your losses exceed your gains in a year, you can:

1. Offset remaining losses against ordinary income — up to $3,000/year
2. Carry the rest forward indefinitely to offset future gains or income

Example: $8,000 in losses, $0 in gains.

• Year 1: deduct $3,000 from ordinary income, save ~$660–$990 (depending on bracket)
• Remaining $5,000 carried to next year

Is It Worth It For Your Portfolio?

Tax-loss harvesting has diminishing returns below a certain portfolio size. Rough thresholds:

If you're using Betterment or Wealthfront, automated tax-loss harvesting is included. For DIY investors, it requires monitoring and intentional action.

When to Harvest

Opportunities arise during market dips. When a fund drops 5–10%, you can harvest and rebuy a substitute. The best years for harvesting are volatile ones — 2020, 2022.

Don't manufacture losses just to harvest them. If an investment is down 3%, transaction costs and the temporary tax timing difference aren't worth it. Look for 8–10%+ drops.

The Deferred Tax Benefit

When you harvest and replace with a similar fund, your new cost basis is lower. This means you'll owe taxes on a larger gain when you eventually sell that substitute fund.

The benefit: you've deferred taxes. A dollar of taxes paid in 30 years is worth less (in real terms) than a dollar paid today. The deferral is valuable, even if it's not elimination.

The Bottom Line

• Sell losing positions to offset gains; immediately rebuy similar-but-not-identical funds
• The wash sale rule: no buyback of the same security within 30 days on either side
• Losses in excess of gains offset up to $3,000/year of ordinary income; excess carries forward
• Most valuable in taxable brokerage accounts during volatile years
• Irrelevant inside 401(k) and IRA — no capital gains tax there anyway

Use our Compound Interest Calculator to see how tax savings reinvested annually compound over 20–30 years.