Tax-Loss Harvesting: How to Reduce Your Investment Taxes

Tax-loss harvesting is the practice of selling investments at a loss to offset capital gains taxes. Done correctly, it can save thousands in taxes annually.

How It Works

Basic concept: When an investment is down, you sell it, realize the loss for tax purposes, and immediately buy a similar (but not identical) investment. Your portfolio composition stays roughly the same, but you’ve “harvested” a tax loss.

Example:

You own $10,000 of Fund A (now worth $7,000)
You sell Fund A for a $3,000 loss
You immediately buy Fund B (similar but not identical)
You now have a $3,000 capital loss to use against gains

Tax Benefits

Offset capital gains: If you have $5,000 in realized capital gains, a $3,000 loss offsets them—you pay taxes only on $2,000 in gains.

Offset ordinary income: You can deduct up to $3,000 in net losses against ordinary income per year. At a 22% tax bracket, that’s $660 in direct tax savings.

Carry forward excess losses: If your losses exceed $3,000, the remainder carries forward to future years indefinitely.

Who Benefits Most

High benefit:

Investors with significant capital gains (large stock sales, business sale)
High-income investors in 24%+ tax brackets
Those with large taxable investment accounts

Low benefit:

Investors primarily in tax-advantaged accounts (401k, IRA)—no capital gains taxes anyway
Low-income investors in the 0% capital gains bracket
Those with mostly long-term buy-and-hold investing

The Wash-Sale Rule: Critical to Understand

The IRS prohibits you from claiming a tax loss if you buy a “substantially identical” security within 30 days before or after the sale.

Safe substitutions:

Sell Vanguard S&P 500 ETF (VOO), buy iShares S&P 500 ETF (IVV) ✅
Sell Fidelity 500 Index Fund, buy Schwab S&P 500 ETF ✅
Sell Apple stock, buy another tech ETF ✅

Wash sale violations:

Sell VOO, buy VOO ❌
Sell S&P 500 fund, buy S&P 500 fund from different company ❌ (courts are split on this)
Sell fund in taxable account, buy same fund in IRA within 30 days ❌

When to Harvest

During market downturns (lots of opportunities)
Before year-end (December especially)
When rebalancing your portfolio anyway

Don’t harvest just for the sake of it: If you have no gains to offset, small losses may not be worth the transaction costs and complexity.

Automating Tax-Loss Harvesting

Robo-advisors (Betterment, Wealthfront) offer automated tax-loss harvesting. They monitor your portfolio daily and harvest losses automatically. Worth considering for taxable accounts with $50,000+.

FAQ

Is tax-loss harvesting worth the complexity? For investors with significant taxable accounts and capital gains, yes—the savings can be substantial. For those primarily in tax-advantaged accounts, the benefit is minimal.

Can I harvest losses in a 401k or IRA? No—these accounts don’t have capital gains taxes, so there’s nothing to harvest.

What’s a realistic annual savings? Wealthfront estimates 0.77% additional return annually for a typical portfolio through tax-loss harvesting. On $500,000, that’s ~$3,850/year.

Use our Investment Return Calculator to see how tax-efficient investing affects your long-term returns.