Tax-loss harvesting: how it works and what it saves

Tax-loss harvesting means selling investments that are worth less than you paid, so the loss reduces the tax on your gains or on your other income. It works only in taxable brokerage accounts, the losses have to be real sales, and the wash-sale rule stops you from selling and buying straight back.

How does tax-loss harvesting work?

Capital gains and losses for the year are netted. Losses first cancel out gains, short-term losses against short-term gains and long-term losses against long-term gains, then across the two. Whatever net gain is left is taxed; a net loss can reduce your other income, up to a limit.

The saving is larger against short-term gains, which are taxed at ordinary rates. Try different amounts in the capital gains tax calculator by entering the net gain.

What if my losses are bigger than my gains?

Up to $3,000 of net capital loss a year ($1,500 if married filing separately) is deducted from your other income, such as wages. Any loss above that carries forward to the next year, where it again offsets gains first and then up to $3,000 of other income.

Example: $5,000 of gains and $15,000 of losses leave a $10,000 net loss. The gains are not taxed (worth about $750 here), $3,000 reduces wages, saving about $660 of federal income tax for a single filer with $90,000 of wages, and $7,000 carries forward.

What is the wash-sale rule?

You cannot deduct a loss on stock or securities if, within 30 days before or after the sale, you:

• buy substantially identical stock or securities,
• acquire them in a fully taxable trade,
• acquire a contract or option to buy them, or
• buy them in your IRA or Roth IRA.

It is also a wash sale if your spouse or a corporation you control buys substantially identical stock. The disallowed loss is added to the cost of the new shares, so you get it later when you sell them, except when the purchase was in an IRA.

Is tax-loss harvesting worth it?

It defers tax more than it removes it. If you buy a similar investment, its lower cost basis means a larger gain when you eventually sell. The benefit is real when the loss offsets gains taxed at high rates now, when it reduces ordinary income by up to $3,000 a year, or when you may never sell the replacement. Harvested losses count in the tax year of the sale, so year-end is when people review them, alongside their estimated tax for the last quarter.