Tax-Loss Harvesting: What It Is and When It May Make Sense

How it works

Realized capital losses can generally be used to offset realized capital gains. If your losses exceed your gains in a given year, you can typically deduct up to $3,000 of the excess against ordinary income, and carry remaining losses forward to future years. By harvesting a loss and reinvesting the proceeds in a different, non-substantially-identical investment, you may maintain market exposure while capturing a tax benefit.

The wash-sale rule

The main constraint is the wash-sale rule: if you buy the same or a “substantially identical” security within 30 days before or after the sale, the loss is generally disallowed for current use. This includes purchases in other accounts you own, and in some cases accounts belonging to your spouse. Automated dividend reinvestment is a frequent, accidental culprit.

What tax-loss harvesting cannot do

It is worth being clear-eyed about the limits of the strategy:

• It applies only to taxable accounts, not IRAs or 401(k)s.
• It defers taxes more often than it eliminates them, since reinvesting at a lower cost basis can mean larger gains later.
• The value depends on your tax bracket now versus in the future.
• Selling solely for tax reasons should never override your investment strategy.

The bottom line

Tax-loss harvesting is a useful tool in the right circumstances, particularly for investors in higher brackets with meaningful taxable accounts. Like most tax strategies, the details matter, and mistakes such as wash-sale violations can undo the benefit. Coordinate with your advisor and tax professional before acting, and remember that tax considerations are one input to an investment decision, not the whole decision.