When you sell an investment for more than you paid, you owe capital gains tax. Tax-loss harvesting is the practice of deliberately selling investments that are down to realize a loss, which then offsets those gains and reduces your overall tax liability. The goal isn't to abandon your investment strategy. It's to use temporary losses as a tax tool before reinvesting in something similar.
How the Offset Works
Say you sold stock A for a $10,000 gain this year. You also hold stock B, which is currently down $6,000 from what you paid. If you sell stock B, that $6,000 loss offsets your gain, meaning you only owe tax on $4,000 instead of $10,000. If your losses exceed your gains, you can deduct up to $3,000 of the remaining loss against ordinary income and carry anything beyond that forward to future tax years.
The Wash-Sale Rule
The IRS has a rule that prevents you from selling a security at a loss and immediately buying it back just to capture the tax benefit. This is the wash-sale rule. If you buy the same or a substantially identical security within 30 days before or after the sale, the loss is disallowed. The workaround is to reinvest in a similar but not identical asset, for example selling a total market index fund and buying a large-cap index fund to maintain market exposure without triggering the rule.
When It Makes Sense to Do It
Tax-loss harvesting is most valuable in high-income years when your capital gains tax rate is higher. It's also worth doing during market downturns when temporary losses are widespread across a portfolio. It's less useful in tax-advantaged accounts like IRAs and 401(k)s, where capital gains taxes don't apply in the same way.
Most major brokerages make it straightforward to identify positions with unrealized losses. Review your taxable accounts before year-end, identify candidates, and execute before December 31. Done consistently, the cumulative tax savings over a career of investing can be substantial.
