How Tax-Loss Harvesting Works
Tax-loss harvesting is selling investments at a loss to offset capital gains taxes. You realize a loss on paper, use it to cancel out gains you made elsewhere, and reduce your tax bill. The IRS lets you apply investment losses dollar-for-dollar against investment gains in the same tax year.
Say you sold Stock A for a $50,000 profit and Stock B is sitting at a $30,000 loss. By selling Stock B before year-end, you reduce your taxable gains from $50,000 to $20,000. At a 15% long-term capital gains rate, that turns a $7,500 tax bill into $3,000—a $4,500 savings from one trade.
If your losses exceed your gains, the IRS lets you deduct up to $3,000 of excess losses against ordinary income per year ($1,500 if married filing separately). Anything beyond that carries forward to future tax years indefinitely. A $100,000 loss in a bad year can offset gains for decades.
The Wash Sale Rule Explained
The IRS won't let you sell a stock at a loss and immediately buy it back. The wash sale rule disallows the tax deduction if you purchase a "substantially identical" security within 30 days before or after the sale. That's a 61-day window total: 30 days before, the sale date, and 30 days after.
"Substantially identical" means the same stock or an option on that stock. It does not mean similar stocks. You can sell shares of one S&P 500 index fund at a loss and immediately buy a different S&P 500 index fund from another provider without triggering a wash sale, as long as the funds track different indexes or use different methodologies. Selling a Vanguard total market fund and buying a Schwab total market fund is a gray area—consult a tax advisor.
If you trigger a wash sale, the disallowed loss gets added to the cost basis of the replacement shares. The loss isn't gone forever—it's deferred until you eventually sell the replacement shares. But you lose the immediate tax benefit, which defeats the purpose of harvesting.
When to Harvest Losses: Timing Strategy
Year-end is the most common harvesting window. Investors review portfolios in November and December to identify positions trading below their cost basis. But waiting until December means missing opportunities earlier in the year when markets dip.
Market downturns are prime harvesting territory. A 20% market correction creates unrealized losses across most portfolios. Harvesting during the dip locks in the tax benefit even if the market recovers. You reinvest in a similar (not identical) fund immediately, so your market exposure stays the same while you bank a tax deduction.
Short-term losses are more valuable than long-term losses because they first offset short-term gains, which are taxed at your ordinary income rate (up to 37%) rather than the lower long-term capital gains rate (0%, 15%, or 20%). A $10,000 short-term loss saves up to $3,700 in taxes. The same loss against long-term gains saves at most $2,000.
Short-Term vs. Long-Term Capital Gains Tax Rates (2025)
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | Up to $48,350 | $48,351 – $533,400 | Over $533,400 |
| Married Filing Jointly | Up to $96,700 | $96,701 – $600,050 | Over $600,050 |
| Head of Household | Up to $64,750 | $64,751 – $566,700 | Over $566,700 |
Source: IRS Revenue Procedure 2024-40. Short-term capital gains (held under 1 year) are taxed at ordinary income rates (10%–37%).
Automated Tax-Loss Harvesting Services
Robo-advisors like Wealthfront, Betterment, and Schwab Intelligent Portfolios offer automated tax-loss harvesting. They monitor your portfolio daily, automatically selling positions that have dropped below cost basis and replacing them with similar (not identical) funds to maintain your asset allocation.
Wealthfront claims their automated harvesting adds 1.8% in annual after-tax returns for a typical portfolio. Betterment estimates 0.77% annually. These numbers depend heavily on portfolio size, volatility, and your tax bracket. The benefit is largest for high-income investors in taxable accounts with significant capital gains.
Automated harvesting catches opportunities you'd miss manually. A portfolio might have harvesting opportunities dozens of times per year during normal market fluctuations. The software never forgets the wash sale window and tracks cost basis across all lots automatically. For portfolios over $100,000 in taxable accounts, the tax savings often exceed the advisory fee.
Manual harvesting still works for simpler portfolios. If you hold a handful of index funds in a taxable brokerage account, reviewing positions quarterly and harvesting during dips is straightforward. The key is tracking your 30-day wash sale windows and reinvesting promptly in a similar but not identical fund.
To calculate the capital gains tax on a specific sale, use the capital gains calculator. To determine the cost basis of shares acquired over multiple purchases, try the cost basis calculator.