Tax loss harvesting is a strategy that lets you offset investment gains or ordinary income by realizing losses on investments which can reduce your tax bill. It's commonly used in taxable brokerage accounts (not retirement accounts like IRAs or 401(k)s).
Disclaimer: Educational process steps only not personalized financial or legal advice and not a complete description of Tax Loss Harvesting rules. Consult your own brokerage adviser before acting.
How It Works (Simple Explanation)
- Sell investments that have lost value (called "realizing a loss").
- Use those losses to: first offset capital gains (short-term losses net against short-term gains first, long-term against long-term, then across), and then deduct up to $3,000 of any leftover loss against ordinary income ($1,500 if married filing separately). Anything beyond that carries forward to future years without expiring.
Example: Tax Loss Harvesting in Action
Let's say you're a single filer with this situation:
- You sold winning investments this year for a $10,000 capital gain.
- You also hold investments that are worth $6,000 less than what you paid, and you sell them to realize the loss.
What Happens at Tax Time:
- Your capital gain = $10,000
- Your realized loss = –$6,000
- You only pay tax on the net gain: $4,000
Instead of paying tax on $10k of profit you sold a stock that had a loss of -$6k to lower taxable amount to $4k.
The savings depend on what the loss offsets. If it offsets short-term gains (taxed like salary, up to 37% federal), a $6,000 loss saves up to about $2,200. If it offsets long-term gains (usually 15% or 20% plus possibly the 3.8% surtax), the same loss saves roughly $900 to $1,400. The 30% used here is just a round illustration.
Bonus: No Gains? Use the Loss Against Income
If you had no gains, you can deduct up to $3,000 of the loss from your salary or other income, saving you:
$3,000 × your marginal tax rate (say 30%) = $900
The rest carries forward to future years.
Important Rule: The Wash Sale Rule
- If you buy the same (or "substantially identical") investment within 30 days before or after the sale, the IRS disallows the loss.
Always wait at least 31 days or buy a similar (but not identical) asset.