Tax-Loss Harvesting

Tax-loss harvesting (TLH) is the practice of intentionally selling investments at a loss to offset realized capital gains (and up to $3,000 of ordinary income per year). It's one of the most powerful legal tax strategies for long-term investors.

The mechanics

1. Identify holdings trading below cost basis in your taxable account.
2. Sell — realizing the loss.
3. Reinvest in a similar but not "substantially identical" security to maintain market exposure.
4. Carry forward unused losses indefinitely.

The wash-sale rule

If you buy back the same or "substantially identical" security within 30 days before or after the sale, the loss is disallowed. The disallowed amount adds to the basis of the new shares.

What counts as substantially identical

• The same stock ticker = clearly identical.
• Two different S&P 500 index funds — the IRS hasn't definitively ruled, but most pros consider them substantially identical and avoid swapping between them.
• An S&P 500 fund and a Total US Market fund are generally treated as not substantially identical (different indexes).

The mechanics in three steps

1. Identify holdings in your taxable account trading below their cost basis.
2. Sell — realizing the capital loss.
3. Reinvest in a similar but not "substantially identical" security to maintain market exposure.

What the harvest does for you

The wash-sale rule

If you buy back the same or "substantially identical" security within 30 days before or after the sale, the loss is disallowed. The disallowed amount adds to the cost basis of the new shares.

• The window is 61 days total: 30 days before, the sale date itself, and 30 days after.
• Applies across all accounts you control — including your IRA and your spouse's accounts.
• Dividend reinvestment (DRIP) within the window can accidentally trigger wash sales.

Standard tax-loss swap pairs

A worked example

Investor in a 32% federal + 9% CA state bracket holds $500,000 of VTI bought at $200/share. VTI drops to $170 — $75,000 unrealized loss. Sell VTI; immediately buy ITOT (different index, similar exposure). Loss is realized.

• Uses against $20,000 of long-term gains realized elsewhere: saves $3,000 (15% LTCG rate × $20k).
• Uses against $3,000 of ordinary income: saves $1,230 (41% combined rate × $3k).
• $52,000 carries forward to future years.

Total current-year savings: ~$4,230. Position has same market exposure.

Common tax-loss harvesting mistakes

• Harvesting in tax-advantaged accounts. No benefit — there's no tax to offset.
• Forgetting the spouse rule. Your spouse buying VTI in their IRA within 30 days disallows the loss.
• Auto-reinvesting dividends. A $30 dividend reinvestment can wash out a $30,000 harvest.
• Switching back too soon. Wait at least 31 calendar days, ideally 35 for safety.
• Harvesting tiny losses. Transaction friction isn't worth it under $1,000 of loss.

Frequently asked questions

Does TLH actually save tax — or just defer it?

Both. Short-term, defers. Long-term, can produce permanent savings if you eventually sell at lower rates (0% LTCG bracket in retirement) or never sell (step-up in basis at death).

How often should I harvest?

2–4 times per year for an active investor. Whenever a position is down meaningfully (> $5,000 loss).

Automated TLH services worth it?

Wealthfront, Betterment, Frec charge ~0.25–0.30% AUM for daily-monitored TLH. Cost-effective at $400k+ in taxable holdings.

Putting this into practice this week

Concepts only matter if they change behavior. Pick the single most relevant action from the above and put it on your calendar — even 15 minutes of action beats hours of further reading without doing anything. The compound benefit of small consistent moves dwarfs the optimization gain from any single decision. Most people fail at finance not because they don't know what to do, but because they don't act on what they already know.

How this connects to the rest of your financial plan

Personal finance is a system, not a list of independent decisions. The choices you make in one area cascade into others: a tax-loss harvest affects your asset allocation, a 401(k) contribution affects your near-term cash flow, a Roth conversion in 2024 affects RMDs in 2050. Sophisticated financial planning is mostly about understanding these second- and third-order effects. The basics that everyone should master first: emergency fund in cash, capture the full 401(k) match, eliminate high-interest debt, max tax-advantaged accounts before taxable, write down a single-page financial plan and review it annually.

Key takeaways

• Understand the mechanics before you optimize the edges. A solid 70% strategy beats a fragile 95% optimization.
• Automate behavior so you don't depend on willpower. Set-it-and-forget-it is the highest-leverage financial habit.
• Match the strategy to your actual situation, not the situation you wish you had or that influencers describe.
• Review annually; ignore daily noise. The market's short-term moves rarely require a response.
• Consistency over decades beats brilliance over months. Time in the market does the work; trying to time it usually destroys it.

The bottom line

The biggest financial wins come from doing the simple things consistently for decades — not from finding the cleverest single trick. Build the foundation first; the optimizations layer on top once the foundation is solid. The investors who end up wealthy aren't the ones who picked the best stocks. They're the ones who saved consistently, kept costs low, took appropriate risk for their horizon, and didn't sell during crashes. Everything else is detail.

Continue your learning at Krovea

Krovea exists to connect every concept on this page to the next one you should read. Use the site-wide search for any term you're unsure about. Run the relevant numbers on a Krovea calculator with your actual situation — projections beat speculation every time. Look up unfamiliar jargon in the A–Z dictionary. Most readers find their first session on Krovea answers one question and surfaces three more — that's how compounding knowledge works. Subscribe to the weekly briefing if you want the highest-impact one topic delivered without the noise of constant financial media.

A final note on financial decision-making

Every concept covered here exists because someone made a costly mistake first and the rule emerged from the consequences. The 401(k) match exists because Americans weren't saving enough. The Roth IRA exists because mid-century retirees got taxed twice on their nest eggs. The wash-sale rule exists because traders abused loss harvesting. Treat each piece of advice not as arbitrary rules to memorize but as the encoded lessons of prior generations of investors. The framework that survives recessions, regulatory changes, and market manias has been stress-tested in ways no individual could replicate. Following the boring conventional wisdom isn't unimaginative — it's the result of selecting for what actually works at scale across millions of investors and dozens of market cycles.

One last thing — when in doubt, do less

The average investor underperforms their own funds by 1–2% per year because of trading mistakes — entering after rallies, exiting after crashes, switching strategies after they stop working. Inaction has a cost, but action has a much bigger one. When you're not sure what to do, the right answer is usually nothing. Pick the next paycheck's contribution, automate it, and look away until tax season.