Tax Loss Harvesting
Offset realized capital gains, capture income tax deductions, and avoid wash sales by substituting correlated index tracking assets.
TL;DR
- Sell paper losers to offset realized
capital-gainsdollar for dollar. - Deduct up to $3,000 in excess losses against
ordinary-incomeannually. - Avoid the IRS
wash-sale-ruleby waiting 31 days or buying substitutes.
Core Harvesting Mechanics
Realizing Paper LossesSelling depressed holdings to transform paper drawdowns into tax assets.
Set realizing paper losses to cost basis minus sale proceeds.Capital Gains OffsettingLosses offset realized capital gains dollar-for-dollar across accounts.
Losses offset realized capital gains dollar-for-dollar across accounts.$3,000 Ordinary Income OffsetDeducting up to $3,000 in excess losses against salary income.
Deducting up to $3,000 in excess losses against salary income.Navigating The Wash Sale Rule
The 61-Day Penalty Window30 days before, day of trade, and 30 days after prohibited from buying.
Check whether repurchase within days is at most 30.Basis Adjustment ConsequenceDisallowed loss is added to the cost basis of the repurchased shares.
Set basis adjustment consequence to repurchase price plus disallowed loss.Cross-Account ViolationBuying identical shares inside an IRA triggers an unrecoverable wash sale.
Buying identical shares inside an IRA triggers an unrecoverable wash sale.ETFs Substitution Strategy
Similar But Not IdenticalSwapping between funds tracking different benchmark indices.
Swapping between funds tracking different benchmark indices.Continuous Market ExposureRemaining 100% invested so you never miss sudden market rebounds.
Set continuous market exposure to 0.Tax Alpha GenerationAcademic studies estimate annual tax alpha between 0.5% and 1.0%.
Set tax alpha generation to annual tax savings divided by portfolio value.Multi-Year Carryforward Rules
Indefinite Loss CarryforwardUnused net capital losses roll forward into future tax years perpetually.
Set indefinite loss carryforward to remaining loss minus 3000.Short-Term vs Long-TermShort-term losses offset short-term gains first before long-term gains.
Set short-term vs long-term to net short term = st gains minus st losses.Estate Basis Step-UpCapital loss carryforwards expire upon death and cannot be inherited.
Capital loss carryforwards expire upon death and cannot be inherited.Tips
- Replace a sold index ETF with a correlated substitute tracking a different index (e.g., swapping
VTIforSCHB) to remain fully invested. - Carry forward unused capital losses indefinitely to shelter future capital gains from taxes across subsequent
tax-years.
Warnings
- Do not repurchase a
substantially-identicalsecurity within 30 days before or after the sale to avoid triggering the wash sale penalty. - Remember that tax-loss harvesting only applies inside taxable
brokerage-accountsand has zero benefit inside IRAs or 401ks.
In Practice
Calculate capital gains tax savings, ordinary income deduction, and multi-year loss carryforward.
An investor harvests a $15,000 capital loss in an ETF while holding $10,000 in realized capital gains in a 35% income bracket.
- 1. Offset realized capital gains: $15,000 loss - $10,000 gain = $5,000 remaining capital loss.
- 2. Taxes saved on capital gains at 20% rate: $10,000 * 0.20 = $2,000 tax savings.
- 3. Apply maximum annual ordinary income offset: Deduct $3,000 against ordinary income.
- 4. Taxes saved on ordinary income offset: $3,000 * 0.35 marginal rate = $1,050 tax savings.
- 5. Roll forward remaining $2,000 unconsumed loss ($5,000 - $3,000) to offset future tax years.
Harvesting $15,000 loss saves $3,050 in current taxes and banks $2,000 future carryforward.
Tax loss harvesting converts paper drawdowns into tangible current and future tax cash savings.
FAQ
The wash sale rule disallows a tax deduction if you purchase a substantially identical stock or fund within 30 days before or 30 days after realizing the tax loss (a 61-day window in total).
The IRS permits individual taxpayers to deduct up to $3,000 in net capital losses against ordinary income per tax year ($1,500 if married filing separately). Any excess loss carries forward indefinitely.
No. Tax-loss harvesting is only applicable in taxable brokerage accounts. Transactions within tax-sheltered accounts like Traditional IRAs, Roth IRAs, or 401(k) plans carry no capital gains tax consequences.