Tax Loss Harvesting: Turn Market Losses Into Tax Wins
Down markets aren't all bad. Strategic loss harvesting creates tax alpha from volatility.
Making lemonade from market lemons
What Is Tax Loss Harvesting?
Tax loss harvesting is the practice of selling investments at a loss to offset capital gains and reduce your tax bill—then immediately reinvesting in similar (but not identical) assets to maintain your portfolio allocation.
Simple Example
You bought:
VTI at $200
Now worth $150
Loss: $50/share
You also have:
$50/share in gains
elsewhere in portfolio
Gain: $50/share
Harvest result:
Sell VTI, buy ITOT
Loss offsets gain
Tax: $0
Avoid the wash sale trap
The Rules You Must Follow
⚠️ The Wash Sale Rule
You cannot buy a "substantially identical" security within 30 days before OR after the sale. If you do, the loss is disallowed.
❌ Wash Sale (Loss Disallowed)
- Sell VTI at a loss
- Buy VTI within 30 days
✓ Valid Harvest (Loss Allowed)
- Sell VTI at a loss
- Buy ITOT immediately
💡 Replacement Security Pairs
| Sell (at loss) | Buy (replacement) | Tracks |
|---|---|---|
| VTI | ITOT or SCHB | Total US Market |
| VOO | IVV or SPY | S&P 500 |
| VXUS | IXUS or SCHF | International |
| BND | AGG or SCHZ | Total Bond |
The tax math
How Losses Are Used
Step 1: Offset Short-Term Gains
Short-term losses first offset short-term gains (taxed at ordinary income rates up to 37%). This provides the biggest tax savings per dollar of loss.
Step 2: Offset Long-Term Gains
Any remaining losses offset long-term gains (taxed at 0%, 15%, or 20%). Still valuable, but less impact than offsetting ordinary income.
Step 3: Deduct From Ordinary Income
Net capital losses (after offsetting all gains) can offset up to $3,000 of ordinary income per year.
Step 4: Carry Forward Forever
Excess losses carry forward indefinitely. Had $50,000 in losses this year? Use what you can, carry the rest to future years. No expiration.
Real-world scenario
Tax Loss Harvesting in Action
2024 Tax Year Example
Portfolio Events:
- Sold stock: $30,000 short-term gain
- Sold ETF: $20,000 long-term gain
- Harvested losses: $25,000
Tax Calculation:
- $25K loss → $30K ST gain = $5K ST gain
- $20K LT gain remains
- $5K ST taxed at 35% = $1,750
- $20K LT taxed at 15% = $3,000
Without Harvesting:
$30K ST @ 35% = $10,500
$20K LT @ 15% = $3,000
Total Tax: $13,500
With Harvesting:
$5K ST @ 35% = $1,750
$20K LT @ 15% = $3,000
Total Tax: $4,750
Tax Savings: $8,750
Maximize your harvesting strategy
Best Practices
Harvest Year-Round
Don't wait until December. Harvest opportunities arise throughout the year during market volatility.
Maintain Exposure
Always buy replacement securities immediately. You're not timing the market—you're capturing tax losses.
Use Specific ID
Select specific tax lots to sell (highest cost basis) rather than FIFO. Maximizes loss harvesting.
Watch All Accounts
Wash sale rule applies across accounts. Don't buy the same security in your IRA within 30 days.
Keep Records
Track cost basis of replacement securities. Your new basis carries over from the sale.
Consider Automation
Some robo-advisors offer automated tax loss harvesting. Can capture small, frequent opportunities.
Situations where harvesting may not make sense
When NOT to Harvest
Skip Harvesting If:
- • In 0% capital gains bracket (no tax to offset)
- • Transaction costs exceed tax savings
- • Would trigger wash sale
- • Replacement fund has higher expense ratio
- • Planning to donate the position soon
Prioritize Harvesting If:
- • Have large realized gains this year
- • In high tax bracket (32%+)
- • Market decline creates opportunities
- • Near year-end with unused losses
- • Have short-term gains to offset
Frequently Asked Questions
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