Tax-loss harvesting in 4 minutes
A common end-of-year tax move, in plain English: sell losing investments to reduce your tax bill — but watch the wash-sale trap.
Tax-loss harvesting is the practice of selling investments that have dropped in value to claim a capital loss, which can offset capital gains and reduce a tax bill.
How it works
Suppose someone sold a stock at a $5,000 gain earlier in the year. Without further action, tax is owed on that gain. If another investment is sitting at a $5,000 loss, that investment can be sold before year-end. The loss offsets the gain. Net taxable amount on those two trades: zero.
When net losses exceed net gains, the IRS allows up to $3,000 to be deducted against ordinary income each year, with the remainder carried forward to future years.
The wash-sale trap
If the same security (or a 'substantially identical' one) is repurchased within 30 days, the IRS disallows the loss under the wash-sale rule. The standard workarounds are waiting 31 days or buying something similar but not identical — for example, swapping one S&P 500 ETF for a different broad-market ETF.