Tax-Loss Harvesting, Explained Without the Mystique
Selling a losing investment creates a loss that can offset gains and a slice of ordinary income — if you avoid the wash-sale trap. What harvesting genuinely saves, what it merely defers, and when it is not worth the trouble.
Published · Taxes · 2 min read
Tax-loss harvesting has acquired an aura of sophistication — robo-advisors advertise it as a headline feature — but the mechanic fits in a sentence: sell an investment that is down, use the realized loss to offset realized gains (and up to $3,000 of ordinary income a year), and reinvest in something similar but not identical so your portfolio barely notices.
What a harvested loss is worth
Losses first cancel gains of the same character — short-term against short-term, long-term against long-term — then cross over. A loss that cancels a short-term gain saves tax at your full marginal rate; one that cancels a long-term gain saves at the lower preferential rate. Leftover losses offset up to $3,000 of ordinary income per year, and anything beyond that carries forward indefinitely. A $10,000 harvested loss for someone facing 24% on short-term gains is worth up to $2,400 in deferred tax.
The wash-sale rule
The tax code will not let you sell purely for the deduction and instantly rebuy. Repurchase the same or a substantially identical security within 30 days before or after the sale, and the loss is disallowed — it gets folded into the cost basis of the new position instead. The standard maneuver is to hold a similar-but-different fund for 31 days (a total-market fund in place of a large-cap index fund, say), or simply wait out the window. The rule also reaches across accounts, including IRAs, where a disallowed loss can vanish permanently.
Deferral, not elimination
Honesty requires this part: harvesting mostly defers tax rather than erasing it. Reinvesting at a lower price lowers your cost basis, so the future gain is larger by exactly the loss you claimed. The genuine wins are narrower — the time value of postponed tax, the chance the future gain is taxed at a lower rate (a retirement-year 0% bracket, a step-up at death, a charitable donation of appreciated shares), and the immediate $3,000 offset against ordinary income taxed at full rates.
When to skip it
Inside a 401(k) or IRA the exercise is meaningless — there are no capital gains to offset. Tiny losses are not worth transaction friction and record-keeping. And selling a position you would not otherwise sell, purely to harvest, puts the tax tail in charge of the investment dog. Check what a realized gain or loss actually does to your bill with the capital gains tax calculator before assuming the maneuver is worth it.
Run your own numbers
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This article is general education, not tax, legal, investment, or financial advice. Figures used in examples are illustrations, not quotes or predictions. For decisions that depend on your full situation, talk to a qualified professional.