Glossary
Tax-loss harvesting
Selling investments at a loss to offset taxable gains and up to $3,000 of ordinary income, while staying invested and avoiding the wash-sale rule.
Tax-loss harvesting is the practice of selling an investment that has fallen below its cost to realize a capital loss, then using that loss to reduce taxes on gains elsewhere. In the US, realized losses first offset capital gains, and any net loss left over can reduce ordinary income by up to $3,000 a year, with the remainder carried forward indefinitely. It applies only to taxable accounts, not to IRAs or 401(k)s.
How it works
The usual approach is to sell the losing position and immediately buy something similar but not "substantially identical," so the portfolio keeps roughly the same market exposure. Buying the same security, or an option on it, within 30 days before or after the sale triggers the wash-sale rule, which disallows the loss for now and adds it to the cost basis of the replacement shares.
What it does and does not do
Harvesting mostly defers tax rather than eliminating it. The replacement holding now has a lower cost basis ($15,000 instead of $20,000 in the example), so a later sale will show a larger gain. The benefit is real when losses offset short-term gains taxed at high rates, when the deferral runs for many years, or when the shares are eventually donated or held until death. Trading costs, the wash-sale window across all your accounts (including a spouse's and IRAs), and drifting away from your intended allocation are the practical traps.