Reduce your tax bill through tax-loss harvesting by identifying losing positions, following wash sale rules, offsetting gains, and timing your trades for maximum benefit.
Review all holdings in taxable brokerage accounts for losses
Only taxable accounts qualify for tax-loss harvesting. Losses in 401(k)s, IRAs, and Roth accounts cannot be harvested because those accounts are already tax-advantaged. Focus exclusively on your non-retirement brokerage accounts.
Compare each position's cost basis to current market value
Your brokerage shows unrealized gains and losses for each holding. Look for positions down $1,000 or more since smaller losses may not justify the effort and trading costs involved.
Separate short-term losses from long-term losses
Short-term losses (held under one year) first offset short-term gains taxed at ordinary income rates (up to 37%). Long-term losses first offset long-term gains taxed at preferential rates (0-20%). Short-term losses save more per dollar.
Check for embedded capital gains distributions in mutual funds
Mutual funds distribute capital gains in November and December even if you did not sell. Harvesting losses before these distributions can offset the gains you are about to receive. Check your fund's estimated distribution schedule online.
Understanding the Wash Sale Rule
Learn the 61-day wash sale window
You cannot buy a substantially identical security within 30 days before or after selling at a loss (61 total days). Violating this rule disallows the loss deduction. The disallowed loss gets added to the cost basis of the new purchase.
Check for wash sales across all accounts including IRAs
The wash sale rule applies across all your accounts, including your spouse's. If you sell a stock at a loss in your brokerage and buy the same stock in your IRA within 30 days, the loss is disallowed permanently in the IRA.
Verify that replacement investments are not substantially identical
Substantially identical means the same security or a nearly identical one. Two S&P 500 index funds from different providers could be considered substantially identical. A total U.S. stock market fund and an S&P 500 fund are generally considered different enough.
Pause dividend reinvestment plans (DRIP) on the sold security
If you have automatic dividend reinvestment enabled, buying shares through DRIP within 30 days of your loss sale triggers a wash sale. Turn off DRIP before selling and wait 31 days before re-enabling it.
Executing the Harvest
Sell the losing position in your taxable account
Use a limit order rather than a market order to control your sale price. If selling a large position, consider selling over 2-3 days to avoid moving the market price, especially for thinly traded securities.
Select the specific tax lots to sell for maximum loss
If you bought shares at different times and prices, sell the lots with the highest cost basis (biggest loss). Change your brokerage's tax lot selection method to specific identification rather than average cost or FIFO.
Purchase a replacement investment immediately to stay invested
Buy a similar but not identical fund on the same day you sell. For example, if you sell a U.S. total market ETF, buy a large-cap ETF. Staying out of the market for 31 days risks missing a recovery that wipes out your tax savings.
Offsetting Gains and Deducting Losses
Calculate your total realized gains for the year
Add up gains from all sales, including mutual fund distributions. Separate short-term gains (taxed at 10-37%) from long-term gains (taxed at 0-20%). Knowing your gain total tells you exactly how much loss you need to harvest.
Apply losses against gains of the same type first
Short-term losses offset short-term gains first. Long-term losses offset long-term gains first. Any remaining losses then cross over to offset the other type. This netting process is automatic on your tax return.
Deduct up to $3,000 of net losses against ordinary income
After offsetting all capital gains, you can deduct up to $3,000 ($1,500 if married filing separately) of remaining losses against wages, salaries, and other ordinary income. At a 24% tax bracket, this saves $720 in federal tax.
Carry forward any unused losses to future tax years
Losses exceeding $3,000 plus all gains carry forward indefinitely. Track carryforward amounts on your tax return each year. Large losses from a market crash can reduce your taxes for many years.
Year-End Timing and Planning
Review your portfolio for harvesting opportunities in October or November
Starting early gives you time to execute trades, swap into replacement investments, and avoid the December trading rush. Waiting until late December risks settlement delays that could push trades into the next tax year.
Ensure trades settle by December 31 for current-year tax benefit
Stock trades settle in one business day (T+1). A trade executed on December 30 settles on December 31. Trades on December 31 settle January 2 and count for the following tax year. Plan accordingly.
Mark your calendar to swap back after the 31-day wash sale period
If you prefer your original investment over the replacement, set a reminder to sell the replacement and rebuy your original holding after 31 days. Factor in the replacement fund's performance during the swap period.
Document all harvesting transactions for tax filing
Keep records of which lots you sold, the loss amount, the replacement purchase, and the 31-day window dates. Your brokerage 1099-B will report the sales, but you are responsible for tracking wash sale compliance across accounts.
Frequently Asked Questions
How much can I deduct from tax-loss harvesting?
Losses offset gains dollar-for-dollar with no limit. After that, deduct up to $3,000 against ordinary income per year. Unused losses carry forward indefinitely. Harvesting $50,000 in losses against $50,000 in gains saves $7,500-$11,900 in capital gains taxes.
What is the wash sale rule and how do I avoid it?
You cannot buy a substantially identical security within 30 days before or after selling at a loss (applies across all accounts including spouse). Wait 31 days, or immediately buy a similar but not identical fund (sell S&P 500 fund, buy total market fund).
Is tax-loss harvesting worth it for small portfolios?
On $50,000, harvesting a 10% loss saves $1,200 offsetting gains at 24%, or $720 via the $3,000 income deduction. Robo-advisors offer automated harvesting on accounts as small as $500. DIY quarterly checks work for most investors.
When is the best time to do tax-loss harvesting?
Opportunities arise year-round during downturns, not just December. Review quarterly and after any 10%+ decline. Harvesting earlier gives losses more time to offset later gains. Waiting until December risks missing chances if markets recover in Q4.