Tax-Loss Harvesting
Definition
The strategy of selling investments at a loss to offset capital gains, reducing your overall tax liability while maintaining your portfolio's market exposure.
Tax-loss harvesting is a tax optimization strategy where you deliberately sell investments that have declined in value to realize capital losses. These losses offset capital gains from profitable sales, reducing your total tax bill. If losses exceed gains, up to $3,000 can offset ordinary income annually.
The key to effective tax-loss harvesting is maintaining your desired market exposure. After selling a losing position, you can immediately buy a similar (but not "substantially identical") investment to stay invested. For example, selling one S&P 500 index fund at a loss and buying a different S&P 500 tracking fund.
The wash sale rule is the main constraint — you cannot buy the same or substantially identical security within 30 days before or after the loss sale. This is straightforward for individual stocks but more nuanced for mutual funds and ETFs that track similar indexes.
Tax-loss harvesting is most valuable in years with large capital gains, such as when you sell a concentrated stock position or rebalance a portfolio. It's also useful for crypto investors who can harvest losses without wash sale restrictions (under current rules).
The strategy doesn't eliminate taxes — it defers them by lowering the cost basis of your replacement investments. However, deferring taxes has real economic value because you can invest the tax savings and compound returns over time. For high-income investors, the annual tax savings from systematic harvesting can be significant.
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Related Terms
Frequently Asked Questions
Is tax-loss harvesting worth it for small portfolios?
It can be, especially if you have gains to offset. Even the $3,000 annual deduction against ordinary income provides value. For someone in the 24% tax bracket, that's $720 in annual tax savings. Automated tracking makes it practical for any portfolio size.
Can you tax-loss harvest crypto?
Yes, and crypto is currently one of the best asset classes for tax-loss harvesting because the wash sale rule doesn't explicitly apply to crypto. You can sell at a loss and immediately rebuy the same token, though this may change with future legislation.