What is tax-loss harvesting?
Tax-loss harvesting is selling a losing investment deliberately — not to exit a position, but to lock in a loss you can use to offset investment gains (or ordinary income). The goal: reduce your tax bill without changing your portfolio.
Example: you hold a total stock market fund worth $10,000 that has dropped to $9,000. You sell it for a $1,000 loss. You immediately buy a similar (but not identical) total stock market fund to stay invested. You now have a $1,000 tax loss to use.
How tax-loss harvesting saves money
If you realised $3,000 in capital gains this year (from selling winners), you can use the $1,000 loss to offset them. Net gain: $2,000, which is taxed instead of $3,000. If your tax rate is 20%, you save $200 in taxes.
If your losses exceed gains, you can carry forward up to $3,000 of losses to offset ordinary income (salary, etc.) each year. Excess losses carry forward indefinitely.
The wash-sale rule: the main gotcha
If you sell a fund for a loss and buy the same fund back within 30 days (30 days before or after the sale), the IRS disallows the loss. This is the wash-sale rule.
How to avoid it: sell the total US market fund at a loss, then buy an international market fund or a different total market fund (same asset class, different fund). Both track market-level returns, so your portfolio stays the same, but the funds are different enough to avoid wash-sale violations.
When to tax-loss harvest
The best time is December, when many investors have losses they can realise before year-end. But losses happen randomly — whenever a fund is down, you have an opportunity.
- After a market crash (2022, 2020, etc.), almost every position is down. This is the easiest time to harvest losses.
- If a single holding has underperformed, you can harvest that loss while staying broadly invested.
- If you are rebalancing anyway (e.g., selling bonds to buy stocks), check if the selling will generate losses.
Real-world example
Year 1: you invest $10,000 in a total stock fund. By year 2, it is worth $8,000 (market downturn). You sell for an $2,000 loss and immediately buy an international stock fund for $8,000. Portfolio value: unchanged. Tax benefit: you can now offset $2,000 in gains or ordinary income.
In year 3, the market recovers, and your international fund is now worth $10,500. You have realised a gain but still owe no tax because you offset the $2,000 gain with your harvested loss.
Who should tax-loss harvest
Tax-loss harvesting is most valuable for:
- High earners in high tax brackets (25%+ tax rate).
- People with taxable brokerage accounts (401k and Roth accounts cannot use losses).
- FIRE seekers with large portfolios — the dollar savings scale with portfolio size.
If you have a small taxable account or low tax bracket, the benefit is smaller. But it is free money: if you are rebalancing anyway, harvesting losses takes 5 minutes and saves hundreds over time.