Tax-Loss Harvesting: A Complete Guide
How It Works
Tax-loss harvesting involves selling investments at a loss to offset capital gains. Short-term losses first offset short-term gains (taxed as ordinary income at up to 37%), then long-term gains (taxed at 15–20%). If losses exceed gains, you can deduct up to $3,000 against ordinary income, carrying excess losses forward indefinitely. The key: you simultaneously buy a similar (but not "substantially identical") investment to maintain your market exposure.
The Wash Sale Rule
The IRS wash sale rule prevents you from claiming a loss if you buy a "substantially identical" security within 30 days before or after the sale. You can work around this by: buying a similar but not identical ETF (selling an S&P 500 fund and buying a total market fund), waiting 31 days to repurchase (though you're out of the market), or using the proceeds in a tax-advantaged account (though cross-account wash sales still apply).
When It Adds the Most Value
Tax-loss harvesting is most valuable for: high-income investors in the 32–37% tax bracket, years with significant realized capital gains (stock sales, RSU vesting), volatile markets that create harvesting opportunities, and taxable investment accounts (not applicable in IRAs/401(k)s). A disciplined advisor can harvest losses throughout the year, not just in December, capturing opportunities that a once-a-year review would miss.
Key Takeaways
- 1.Losses offset gains dollar-for-dollar, starting with short-term gains
- 2.The wash sale rule requires buying "similar but not identical" replacements
- 3.Tax-loss harvesting is most impactful for high-income investors
- 4.Year-round monitoring captures more opportunities than annual reviews
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