How to Use Tax-Loss Harvesting to Reduce Your Investment Tax Bill

How to Use Tax-Loss Harvesting to Reduce Your Investment Tax Bill

Tax-loss harvesting is a legal strategy to reduce your tax bill by deliberately selling investments at a loss to offset gains elsewhere in your portfolio.

How It Works

When you sell an investment for less than you paid, you realize a capital loss. That loss offsets capital gains dollar-for-dollar. If your losses exceed your gains, you can deduct up to $3,000 against ordinary income per year. Remaining losses carry forward to future years indefinitely.

The Wash Sale Rule — The Critical Constraint

You cannot buy a "substantially identical" security within 30 days before or after the sale, or the IRS disallows the loss. This is the wash sale rule. Buying back the exact same ETF the next day disqualifies the loss entirely.

How to Stay Invested While Harvesting

The trick is replacing your sold position with a similar (but not identical) investment. Sell your S&P 500 index ETF (say, VOO) and immediately buy a different S&P 500 ETF (IVV or SPY) from a different provider. Both track the same index, but they are not "substantially identical" securities under the IRS interpretation used by most tax practitioners. You stay fully invested with essentially no market exposure change.

Which Brokers Automate This

Robo-advisors like Wealthfront and Betterment automate tax-loss harvesting continuously throughout the year. For DIY investors, you need to monitor your portfolio and harvest manually — typically in volatile markets when losses present themselves.

When It Matters Most

Tax-loss harvesting has the highest impact in high-income years, years when you have large realized capital gains (like selling a business or real estate), and in December when you can survey the full year''s picture. For investors in the 0% capital gains bracket, it provides no benefit.