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Tax-loss harvesting is the practice of selling investments that have dropped in value to claim a capital loss, which offsets capital gains and reduces your tax bill. Done right, it's free money. Done wrong, it triggers IRS penalties.
The basic mechanics
Capital losses offset capital gains dollar-for-dollar. If you have $5,000 in gains and harvest $5,000 in losses, your taxable amount becomes zero. If your losses exceed your gains, you can deduct up to $3,000 against ordinary income. Anything beyond $3,000 carries forward to future years indefinitely.
The wash-sale rule
If you sell at a loss and buy back the same security (or 'substantially identical' one) within 30 days, the IRS disallows the loss. The fix: either wait 31 days before rebuying, or buy a different but similar security. For example, sell VOO (S&P 500 ETF) and buy IVV (different S&P 500 ETF). Different fund, similar exposure, generally not considered substantially identical.
When it's most valuable
- High-income years when your tax rate is highest
- Years with significant realized gains elsewhere
- Down market years when there are losses to harvest
- Late in the year when you can see the full picture
When to skip it
- Your loss is small (under $1,000): not worth the complexity
- You're in the 0% long-term capital gains bracket: the loss has limited value
- You're in tax-deferred accounts only: no taxable events to offset
What this lesson is NOT
This is not tax advice, and harvesting is not free money. It defers tax, it does not erase it, and it only helps in the right situation. The wash-sale rule is easy to trip across accounts, and getting it wrong disallows the loss. Confirm your own case with a tax professional before harvesting.
Quick check on this lesson
Answer each question and we’ll show you why the right answer is right, and why the others aren’t.
- 1.
Per the lesson, what is tax-loss harvesting?
- 2.
Per the lesson, if your harvested losses exceed your capital gains in a given year, what happens to the excess?
- 3.
Per the lesson, how can you claim a tax loss while staying invested in similar exposure?
- 4.
Per the lesson, when is tax-loss harvesting most valuable?
- 5.
Per the tax callout, where does the wash-sale rule apply?
0 of 5 answered