What Is Tax-Loss Harvesting?
Tax-loss harvesting is a strategy that helps investors reduce taxes by selling investments that have lost value and using those losses to offset gains.
It sounds complicated, but the concept is simple:
When you sell an investment for less than you paid, that loss can offset capital gains from other profitable investments — or even reduce your taxable income.
Used wisely, tax-loss harvesting helps you keep more of what you earn while staying invested for the long term.
1. Understand How It Works
Let’s say you bought $5,000 worth of stock, but now it’s worth $3,000.
If you sell it, you realize a $2,000 loss.
That $2,000 can:
- Offset any capital gains you made from other investments.
- Offset up to $3,000 of ordinary income per year (if your losses exceed your gains).
- Carry forward to future years if it’s more than $3,000.
You can then reinvest in similar assets — but not the exact same one — to maintain your market exposure.
2. Beware of the Wash-Sale Rule
The wash-sale rule is the biggest trap for beginners.
It says: if you sell a security at a loss and buy the same or “substantially identical” one within 30 days before or after the sale, you can’t claim that loss for tax purposes.
To avoid triggering it:
- Wait at least 31 days before repurchasing the same asset.
- Or, buy a similar but not identical investment.
- Example: Sell Vanguard S&P 500 ETF (VOO) and buy Schwab U.S. Large-Cap ETF (SCHX) instead.
This keeps your portfolio balanced while staying IRS-compliant.
3. Focus on Taxable Accounts
Tax-loss harvesting only applies to taxable brokerage accounts.
If your investments are inside:
- 401(k)s
- IRAs
- Roth IRAs
Then you can’t claim gains or losses until you withdraw the money.
That’s why it’s best to use this strategy in regular brokerage accounts where taxable events occur annually.
4. Keep Good Records
Every sale, gain, and loss must be reported on your IRS Schedule D and Form 8949.
Your brokerage typically provides these automatically, but it’s smart to track your own records too.
Note:
- Short-term losses (held < 1 year) offset short-term gains first.
- Long-term losses (held > 1 year) offset long-term gains first.
Accurate recordkeeping prevents errors and ensures your tax return matches your investment statements.
5. Reinvest Strategically
Once you sell a losing position, don’t just let the money sit.
Reinvest it right away into a similar asset to stay exposed to the market’s potential recovery.
Example:
- Sell an underperforming tech ETF
- Reinvest in a different tech ETF or a total market fund
This way, your portfolio keeps growing while you still benefit from the tax deduction.
6. Use Automated Tools and Advisors
Many modern platforms now automate tax-loss harvesting for you.
Popular options include:
- Wealthfront and Betterment – automatically scan your portfolio for loss opportunities.
- Fidelity and Charles Schwab – offer tax-efficient portfolios and harvesting guidance.
Automation ensures you capture losses efficiently without manually tracking each trade.
7. Don’t Let Taxes Drive Every Decision
The goal of tax-loss harvesting isn’t to lose money — it’s to optimize your taxes while staying invested.
Avoid selling assets just for a tax break if it hurts your long-term investment goals.
Always consider:
- Your overall strategy
- Market trends
- Portfolio diversification
Tax savings are great, but long-term growth matters more.
Bonus Tip: Pair It with Tax-Gain Harvesting
If your income is low this year, consider the opposite strategy — tax-gain harvesting — where you sell profitable investments to reset your cost basis at a lower tax rate.
Used together strategically, these methods can balance your taxes across multiple years and maximize after-tax returns.
Final Thoughts
Tax-loss harvesting is one of the smartest tools for improving investment efficiency and reducing tax drag.
By understanding the rules, avoiding wash sales, and staying invested, you can minimize taxes and keep your portfolio growing smoothly year after year.
Smart investors don’t just earn — they manage what they keep.