When an investment in a taxable brokerage account drops below what you paid, that paper loss has real cash value at tax time — if you harvest it. Tax-loss harvesting means intentionally selling a losing position to lock in the capital loss, using it to cancel out taxable gains (and a slice of ordinary income), while keeping your overall investment plan on track.
How losses offset gains
The tax code nets your capital gains and losses each year in a set order:
- First, losses offset gains of the same type (short-term against short-term, long-term against long-term).
- Then any remaining loss offsets the other type of gain.
- If losses still remain, up to $3,000 per year can offset ordinary income (wages, interest). That $3,000 limit has been fixed for decades and is not inflation-adjusted.
- Anything left over carries forward indefinitely to future tax years.
Because short-term gains are taxed at your higher ordinary rates while long-term gains get the preferential 0/15/20% rates, using losses to erase short-term gains is especially valuable.
Find your marginal rate →The value of harvesting depends on your rates. Use the calculator to see the marginal bracket your ordinary income falls in.The wash-sale rule — do not skip this
The catch is the wash-sale rule. If you sell a security at a loss and buy the same or a "substantially identical" security within 30 days before or after the sale, the IRS disallows the loss for now and adds it to the basis of the replacement shares. The rule exists to stop people from claiming a loss while never really giving up their position.
The common workaround is to buy a similar but not identical investment during the wait — for example, swapping one broad S&P 500 fund for a total-market or different-provider index fund so you keep comparable market exposure without triggering the rule. After 31 days you can switch back if you like. Be careful: the wash-sale rule can reach across accounts, including purchases in your IRA and, in many interpretations, a spouse's accounts, and it applies to automatic dividend reinvestment.
It is deferral, not free money. Selling and rebuying resets your cost basis lower, so you may owe more when you eventually sell the replacement. The benefit comes from postponing tax (letting the saved money compound), converting high-taxed short-term gains into deferral, and — at the end — the possibility of a step-up in basis at death that can erase the deferred gain entirely for heirs.
When it is worth the effort
Harvesting shines during market downturns, for investors with concentrated gains to offset, and for high earners facing the top capital-gains rate plus the 3.8% Net Investment Income Tax. It is far less useful in tax-advantaged accounts (401(k)s and IRAs have no taxable gains to offset) and can even backfire for someone in the 0% long-term capital-gains bracket, where gain harvesting (deliberately realizing gains at 0%) may make more sense than loss harvesting.
Many robo-advisors automate daily tax-loss harvesting, and it can add a modest but real boost to after-tax returns. Just keep the strategy subordinate to your actual investment plan — never let the tax tail wag the portfolio dog — and confirm the wash-sale details with a tax professional, since the "substantially identical" line is a judgment call.