The Moment
Some of your investments are down, and you have heard that you can sell them to reduce your tax bill. This is tax-loss harvesting — and it is one of the few legal ways to turn a losing investment into a tax benefit.
But it is often oversold. Tax-loss harvesting defers taxes; it rarely eliminates them. Understanding the mechanics prevents you from making the process more complex than the benefit warrants.
How It Works
The mechanics: 1. You sell an investment that has declined below your purchase price (creating a "realized loss"). 2. You use that loss to offset capital gains from other investments. 3. If your losses exceed your gains, you can deduct up to $3,000/year against ordinary income. 4. Remaining losses carry forward to future years.
Example: You bought $10,000 of a total market fund that is now worth $7,000. You sell, realizing a $3,000 loss. You immediately buy a similar (but not identical) fund to stay invested. The $3,000 loss offsets $3,000 in capital gains or ordinary income, saving you $660-$1,110 in taxes depending on your bracket.
The catch — wash sale rule: If you buy a "substantially identical" security within 30 days before or after the sale, the IRS disallows the loss. You cannot sell VTSAX and buy VTSAX back the next day. You can sell VTSAX and buy a different total market fund (FSKAX, ITOT) — the IRS considers different funds from different providers to be not "substantially identical."
When It Makes Sense
Harvest when: - You have taxable brokerage accounts with unrealized losses - You are in the 22%+ tax bracket (higher bracket = larger tax savings) - You have capital gains to offset (realized gains from selling winners) - You can replace the sold investment with a similar but not identical fund
Do not bother when: - All your investments are in retirement accounts (401(k), IRA) — tax-loss harvesting does not apply - Your total income is low enough that capital gains are taxed at 0% ($47,025 single / $94,050 married in 2025) - The loss is very small ($200-$500) — the complexity is not worth the $50-$100 tax savings - You would have to go to cash and risk missing a market rebound
Run Your Numbers
See how tax savings compound when reinvested over time.
Compound Growth Projector
What to explore next
- →How do I choose a replacement fund for tax-loss harvesting?
- →What is asset location and how does it reduce taxes?
- →Should I use a robo-advisor for tax optimization?
Frequently Asked Questions
Does tax-loss harvesting eliminate taxes or just defer them?
Mostly defer. When you harvest a loss and buy a replacement fund, your new cost basis is lower. When you eventually sell the replacement, you will owe capital gains tax on the larger gain. The benefit is the time value of money — paying taxes later is better than paying them now. If you hold until death, the stepped-up basis does eliminate the deferred gain.
Should I use automated tax-loss harvesting (Wealthfront, Betterment)?
If you have $50,000+ in taxable accounts and are in the 24%+ bracket, automated harvesting can add 0.5-1.5% in after-tax returns annually. Below $50,000 or in lower brackets, the benefit is marginal and the added complexity of tracking cost basis across multiple funds may not be worth it.