Tax-Loss Harvesting Guide
Tax-loss harvesting is the practice of selling investments that have declined in value to realize a capital loss, which can offset capital gains and up to $3,000 of ordinary income per year.
When an investment in your taxable account drops below what you paid for it, selling it creates a realized capital loss. This loss can offset realized capital gains from other investments in the same tax year. If your losses exceed your gains, you can use up to $3,000 ($1,500 if married filing separately) to offset ordinary income, with remaining losses carried forward indefinitely.
For example, imagine you sold Stock A for a $10,000 gain and Stock B for an $8,000 gain earlier this year, giving you $18,000 in realized gains. You also hold Stock C, purchased for $25,000, now worth $15,000. By selling Stock C, you realize a $10,000 loss, reducing your net gains to $8,000. You save tax on $10,000 of gains — at 15% long-term rate, that's $1,500 in federal tax savings. The $5,000 remaining loss carries forward.
Tax-loss harvesting is most effective in taxable accounts. In tax-advantaged accounts like IRAs and 401(k)s, losses inside the account don't generate tax benefits. Be careful with the wash sale rule: if you repurchase the same or substantially identical security within 30 days before or after the sale, the loss is disallowed.
When to Harvest Losses
The optimal time is late in the year when you have a clear picture of realized gains. However, market downturns create opportunities at any point. A disciplined approach reviews your portfolio quarterly for loss positions, especially volatile holdings like individual stocks or sector ETFs. Many brokerage platforms now offer automated tax-loss harvesting for a fee.
FAQs
Can I deduct more than $3,000 of losses against ordinary income?
No. If your net capital losses exceed $3,000 ($1,500 if married filing separately), the excess must be carried forward to future tax years. There is no limit on how many years you can carry forward losses. For example, a $50,000 loss could offset $3,000 of ordinary income for over 16 years, plus any capital gains in the meantime.
Does tax-loss harvesting work in a down market?
Yes, down markets are ideal for harvesting. The 2022 bear market created massive loss-harvesting opportunities. When the S&P 500 fell 19% in 2022, investors who sold and swapped into similar funds could harvest millions in losses. As the market recovered in 2023 and 2024, they had loss carryforwards to offset gains.
Should I harvest losses if I plan to hold long-term?
Yes. Harvesting losses doesn't mean abandoning your investment strategy. You can sell Fund A (which tracks the S&P 500) at a loss and immediately buy Fund B (which also tracks the S&P 500 but from a different provider), maintaining market exposure while realizing the tax benefit. Just ensure the funds are not "substantially identical" to avoid wash sale issues.