Tax Loss Harvesting Explained

When markets dip, most of us focus on the losses in our accounts. But under the right conditions, some of those losses can work in your favor at tax time. 

Tax loss harvesting is a strategy that uses investments that have gone down in value to help lower your tax bill, all while keeping your portfolio aligned with your goals. It’s not just for seasoned investors or big portfolios. With the right approach, it can be a valuable tool for many households with taxable accounts. 

What is Tax Loss Harvesting?

Tax loss harvesting (sometimes called tax loss selling) involves selling an investment that’s worth less than what you paid for it. By doing so, you “realize” a capital loss that can offset capital gains or reduce taxable income. 

Think of it as turning an unrealized paper loss into a tax asset. You’re not erasing the loss, but you’re putting it to work to reduce what you owe. 

This strategy applies only to taxable (non-retirement) investment accounts, not IRAs, 401(k)s, or other tax-deferred accounts.

How It Works: A Simple Example

Imagine you bought shares of a mutual fund for $60,000. The market dips, and now it’s worth $30,000. That’s a $30,000 loss on paper. 

If you sell the investment, you’ve now realized that loss. The IRS allows you to:

• • Offset capital gains from other investments. 
    If you sold another investment for $10,000 gain, you could use $10,000 of your harvested loss to offset that gain completely. 
  • Reduce taxable income by up to $3,000 per year. 
    If your losses exceed your gains, you can apply up to $3,000 of the remaining loss to reduce your taxable income this year, and carry forward the rest for future years. 
  • Stay invested by reinvesting in a similar, but not identical, investment.
    This avoids missing potential market rebounds while complying with IRS rules. 

The Wash Sale Rule

The wash sale rule prevents you from claiming a tax loss if you buy the same, or a “substantially identical,” investment within 30 days before or after the sale. 

This means if you sell a stock at a loss, you can’t immediately repurchase it or purchase an ETF or mutual fund that holds nearly the same securities. Doing so would invalidate the loss for tax purposes. 

Helpful link: See the IRS’s official wash sale rule explanation for the technical details. 

Why Tax Loss Harvesting Matters

Tax loss harvesting can help in three ways:

• • Lower taxes in the current year by offsetting gains or reducing income. 
  • Smooth future tax bills by carrying forward unused losses. 
  • Rebalance your portfolio by replacing underperforming investments with ones that better match your strategy. 

When coordinated with other tax strategies, like Roth conversions or charitable giving, harvesting can be part of a bigger picture plan to manage your lifetime tax liability. 

When It Makes Sense

Tax loss harvesting works best when:

• • You have taxable accounts with investments that have declined in value. 
  • You’ve realized capital gains that could be offset. 
  • You want to rebalance without adding to your tax bill. 

It’s especially common toward year-end, but can be used any time market conditions create losses worth realizing. 

When to Think Twice

• • Selling would trigger higher taxes elsewhere (e.g., on dividends or interest).
  • You’d lose a position you want to keep and can’t find an acceptable replacement investment.
  • Your losses are small and not worth the transaction costs or complexity.

How It Fits Into a Larger Plan

Tax loss harvesting isn’t a stand-alone solution. It works best as part of a comprehensive wealth management approach that includes:

• • Ongoing portfolio monitoring
  • Goal-based financial planning
  • Strategic tax planning for both the short and long term
  • Regular rebalancing to maintain your desired asset mix

The Bottom Line

Tax loss harvesting can be a smart way to turn market losses into tax opportunities, but it’s most effective when it’s tailored to your personal situation. A Wealth Manager can help you decide when to harvest, what to sell, and how to reinvest without running afoul of IRS rules. 

Ready to explore whether tax loss harvesting makes sense for you? Start a conversation with our team and see how this strategy fits into your plan.