Tax Strategy
Tax-Loss Harvesting: The Free Tax Break Most Investors Miss
Tax-loss harvesting converts investment losses into tax savings — without changing your market exposure. Here is how to do it correctly and what the wash-sale rule prohibits.
5 min read
Quick answer
Tax-loss harvesting sells investments at a loss to realize capital losses that offset capital gains dollar-for-dollar. Losses exceeding gains can offset up to $3,000 of ordinary income per year, with excess losses carrying forward indefinitely. The wash-sale rule prohibits repurchasing the same or a substantially identical security within 30 days before or after the sale — but allows purchasing a similar (non-identical) fund immediately to maintain market exposure. Done correctly, tax-loss harvesting defers taxes rather than eliminates them, accelerating compounding on the deferred amount.
Written by
Morgan Lee
WorkAINow financial planning editor
Reviewed and updated
May 2026 • 5 min read
Corrections
hello@workainow.comHow tax-loss harvesting works
Tax-loss harvesting is the practice of selling an investment that has fallen below its purchase price to realize a capital loss. That loss then offsets capital gains from other investments sold at a profit, reducing or eliminating the tax owed on those gains.
Capital losses first offset capital gains of the same type: short-term losses against short-term gains, long-term losses against long-term gains. If losses exceed gains of the same type, they can offset gains of the other type. If total losses still exceed total gains, up to $3,000 per year can be deducted against ordinary income (wages, salaries). Any remaining unused losses carry forward to future tax years with no expiration.
The key insight is that harvesting preserves market exposure. You sell an investment at a loss, immediately purchase a similar (but not substantially identical) investment, and maintain roughly the same portfolio exposure to market movements. The economic position is nearly unchanged — but you have crystallized a tax benefit that can be worth thousands of dollars.
The wash-sale rule: what you cannot do
The wash-sale rule is the critical constraint on tax-loss harvesting. It prohibits claiming a tax loss on a security if you purchase a 'substantially identical' security within 30 days before or after the sale, across all your accounts including IRAs and your spouse's accounts.
Selling a Vanguard S&P 500 ETF at a loss and buying a Fidelity S&P 500 ETF immediately after does not trigger the wash-sale rule — they track the same index but are not substantially identical securities. Selling an S&P 500 ETF and immediately buying an S&P 500 index mutual fund from the same provider is a gray area. Selling a stock and buying the same stock within 30 days is clearly a wash sale.
If a wash sale is triggered, the loss is not permanently lost — it is added to the cost basis of the replacement purchase, deferring the loss to a future sale. But the timing benefit disappears, which is often the primary purpose of harvesting. Careful security selection when executing a harvest is essential.
When to harvest and what to look for
Tax-loss harvesting opportunities arise when investments fall below their purchase price (cost basis) in a taxable account. Market volatility creates these opportunities regularly. The best time to review for harvesting is during market corrections — when prices fall 10–15% from recent highs, many positions across a portfolio may be below cost basis simultaneously.
Prioritize positions with the largest unrealized losses relative to the tax savings at your marginal rate. A $5,000 loss saves approximately $1,850 in taxes for a 37% combined federal/state taxpayer — a material benefit from a short-term administrative action.
Tax-loss harvesting only applies to taxable brokerage accounts. Losses in IRAs, 401(k)s, and other tax-advantaged accounts have no tax impact because gains in those accounts are not taxed annually. Focus entirely on taxable account positions when screening for harvest candidates.