Tax-loss harvesting is the practice of intentionally selling investments that have declined in value to generate a capital loss — which offsets capital gains from other investments, reducing your tax bill. It sounds counterintuitive (selling losers on purpose) but the key insight is: you immediately reinvest in a similar investment, maintaining your market exposure. The portfolio position is essentially the same; the tax liability is lower.

How Tax-Loss Harvesting Works: Step by Step

  1. Identify a losing position. You own $30,000 of an international stock ETF you bought at $40,000 — a $10,000 unrealized loss.
  2. Sell the losing position. You realize the $10,000 loss. This triggers a capital loss on your tax return.
  3. Immediately reinvest in a similar fund. You buy $30,000 of a different international ETF (same geographic exposure, different fund provider). You're still invested in international stocks — market exposure unchanged.
  4. The loss offsets your gains. You also sold another fund this year at a $10,000 gain. The $10,000 loss wipes out the $10,000 gain — net capital gain: $0. Tax owed: $0 instead of $1,500–$2,000.
  5. Wait 30 days (or don't switch back). The wash-sale rule prohibits buying the identical fund back within 30 days. Since you bought a different fund, there's no issue — you can hold indefinitely.

The Wash-Sale Rule: The Most Important Constraint

The IRS wash-sale rule (IRC Section 1091) disallows a capital loss if you buy the same or a "substantially identical" security within 30 days before or after the sale. Violating it doesn't create a penalty — the disallowed loss is added to your cost basis of the new shares — but you lose the current-year tax benefit.

What triggers a wash sale:

  • Selling VTI (Vanguard Total Market) and buying VTI again within 30 days
  • Selling VTSAX (Vanguard Total Market mutual fund) and buying VTI (ETF of same index) within 30 days — considered substantially identical
  • Selling an S&P 500 fund and buying another S&P 500 fund from the same provider within 30 days — arguable wash sale

What doesn't trigger a wash sale:

  • Selling VTI and buying ITOT (iShares Core S&P Total U.S. Stock Market) — same market, different provider, different underlying index
  • Selling VTI and buying SCHB (Schwab U.S. Broad Market) — similar exposure, different index methodology
  • Selling an international developed market ETF and buying a different international developed market ETF from another provider

The "substantially identical" standard is vague and the IRS hasn't issued detailed guidance on ETF-to-ETF switches. The safest approach: use funds from different providers tracking different (but similar) indexes. VTI (CRSP US Total Market) and ITOT (S&P Total Market Index) are different indexes; the IRS has not declared these substantially identical, and tax professionals generally treat them as acceptable for TLH purposes.

Real Dollar Savings by Tax Bracket

Suppose you have $15,000 in losses to harvest against $15,000 in short-term gains:

Tax Bracket Short-Term Rate Tax Without TLH Tax With TLH Total Savings
22% bracket22% + 5% state$4,050$0$4,050
24% bracket24% + 5% state$4,350$0$4,350
32% bracket32% + 5% state$5,550$0$5,550

For long-term gains at 15% federal + 5% state, harvesting $15,000 of losses saves $3,000 in the same scenario. The higher your bracket and the shorter-term your gains, the more valuable each dollar of loss becomes.

What Happens When Losses Exceed Gains

If your capital losses exceed your capital gains, the excess can offset up to $3,000 of ordinary income per year (the same $3,000 limit has existed for decades, unadjusted for inflation). For someone in the 22% bracket + 5% state, that's a $810 tax saving from the ordinary income deduction.

Any remaining loss beyond gains + $3,000 carries forward indefinitely to future tax years. A $50,000 loss in a down year might take multiple years to fully utilize — but it's never wasted, just deferred.

When Tax-Loss Harvesting Makes Sense

  • Taxable brokerage account with losses available: Most practical when markets have dropped or specific holdings underperformed
  • Capital gains from rebalancing or selling appreciated positions: You have a tax liability from other transactions that losses can offset
  • Higher tax bracket (22%+): The savings per dollar of loss harvested are proportionally larger
  • Mid-year or year-end timing: Check your unrealized loss positions in November for December execution

When Tax-Loss Harvesting Doesn't Apply

  • IRA or 401(k): No tax events from trading; no losses to harvest
  • 0% capital gains bracket: Single filers under ~$47,000; married under ~$94,000 pay 0% on long-term gains — harvesting has limited value
  • Near-term buyback needed: If you need the exact position back within 30 days, a replacement fund may not be available or acceptable
TLH doesn't eliminate the tax — it defers it. Your replacement fund has a lower cost basis (you bought it at $30,000 when the old fund was $40,000). When you eventually sell the replacement fund, you'll owe tax on a larger gain. The benefit is the time value of money: $4,000 you don't pay this year can compound for 20 years before you eventually owe it. At 7% annual return, that $4,000 deferred tax becomes ~$15,000 in your portfolio over 20 years — making TLH genuinely valuable even with deferral.

Use the tax-loss harvesting calculator to see exact tax savings for your gain amount, loss amount, gain type, and tax bracket. To understand the broader context of minimizing investment costs, read the ETF vs mutual fund guide — ETFs are typically the better vehicle for TLH due to intraday trading flexibility and a wider choice of near-identical replacement funds. And if you're just getting started with low-cost investing, the index fund investing guide covers the complete setup from account choice to fund selection.

Run the Numbers