How Does Tax-Loss Harvesting Reduce Your Tax Bill?
When you sell a losing investment, the realized loss offsets realized gains dollar-for-dollar. If you have $10,000 in gains and $7,000 in losses, only $3,000 of gains are taxable. If losses exceed gains, up to $3,000 can offset ordinary income annually. Remaining losses carry forward to offset gains or income in future years.
What Is the Wash-Sale Rule and How Does It Limit Tax-Loss Harvesting?
The wash-sale rule disallows a loss if you buy a 'substantially identical' security within 30 days before or after the sale. To harvest the loss legitimately, you must wait 31 days before buying back the same security or purchase a similar but not identical investment immediately to maintain market exposure during the waiting period.
When Does Tax-Loss Harvesting Make the Most Sense?
It is most beneficial in years with large capital gains, when you are in a high tax bracket, and when you hold investments in taxable accounts (it does not apply in IRAs or 401(k)s). Year-end is a common time to review, but harvesting can occur any time a significant loss is available and transaction costs are reasonable.
Frequently asked questions
Does tax-loss harvesting permanently eliminate a tax obligation?
No — it defers it. When you sell the replacement investment later, your cost basis is lower, so the eventual gain is larger. The strategy's value lies in deferring taxes to the future and potentially realizing gains at lower rates.
Can I harvest losses in my 401(k) or IRA?
No. Tax-loss harvesting only applies to taxable brokerage accounts. Retirement accounts like IRAs and 401(k)s grow tax-deferred or tax-free, so losses inside them have no immediate tax benefit.