Tax-loss harvesting means selling an investment at a loss so the loss can offset taxable capital gains. If losses exceed gains, a limited amount can offset ordinary income, and unused losses can carry forward.
The strategy sounds simple, but the wash sale rule can ruin the deduction if you buy the same or substantially identical security too close to the sale.
If you need the 2026 capital gains brackets, see Capital Gains Tax 2026. If your taxable account uses broad ETFs, read VTI vs VOO vs VT in 2026.
What Tax-Loss Harvesting Does
Tax-loss harvesting can:
- offset realized capital gains
- offset up to $3,000 of ordinary income if losses exceed gains
- carry unused losses forward to future years
- help rebalance a taxable portfolio
- improve after-tax returns when done carefully
It does not turn a bad investment into a good one. A tax loss is useful because it reduces tax, but the investor still lost money economically.
Capital Loss Ordering
Capital gains and losses are separated into short-term and long-term categories.
- Short-term: asset held one year or less.
- Long-term: asset held more than one year.
Losses first offset gains of the same type. Then excess losses can offset the other type. If total capital losses exceed total capital gains, up to $3,000 can generally offset ordinary income for the year, or $1,500 if married filing separately.
Unused losses carry forward.
The Wash Sale Rule
The wash sale rule generally disallows a loss deduction if you sell stock or securities at a loss and buy substantially identical stock or securities within the 61-day window that starts 30 days before the sale and ends 30 days after the sale.
The disallowed loss is not usually gone forever. It is generally added to the basis of the replacement shares, and the holding period may be adjusted. But the current-year deduction is delayed.
Wash Sale Window
| Day | What happens |
|---|---|
| -30 to -1 | Buying substantially identical securities can trigger a wash sale |
| 0 | Sale at a loss |
| +1 to +30 | Buying substantially identical securities can trigger a wash sale |
The window includes purchases before the sale. This is a common mistake for investors who buy more shares, then sell older shares at a loss.
ETFs and “Substantially Identical”
The tax code does not give a clean public list of ETF pairs that are or are not substantially identical. Investors usually avoid replacing an ETF with another ETF tracking the exact same index.
Lower-risk replacement ideas often involve exposure that is similar but not identical:
- total U.S. market fund replaced with a different broad U.S. index fund
- S&P 500 fund replaced with a total U.S. market fund
- developed international fund replaced with a broader ex-U.S. fund
This is an area where judgment matters. If two funds track the same index and hold nearly the same portfolio, the wash-sale risk is higher.
IRA and Spouse Mistakes
Wash sales can occur across accounts. A taxable-account loss can be affected if you buy substantially identical securities in:
- another taxable account
- a traditional IRA
- a Roth IRA
- a spouse’s account, depending on filing and circumstances
- automatic dividend reinvestment
The IRA version is especially painful because the loss can be permanently lost rather than simply deferred in an obvious replacement basis.
Dividend Reinvestment Can Cause Wash Sales
Automatic dividend reinvestment can accidentally buy replacement shares during the wash-sale window. If you plan to harvest losses, consider turning off reinvestment for the specific position before selling.
This is especially important for monthly dividend funds, bond funds, and ETFs with frequent distributions.
Tax-Loss Harvesting Example
Assume you sell Fund A for a $6,000 loss. You have $4,000 of realized long-term capital gains in the same year.
Result:
- $4,000 loss offsets the $4,000 gain.
- $2,000 remaining loss can offset ordinary income.
- No carryforward remains.
If the remaining loss were $8,000, then $3,000 could generally offset ordinary income and $5,000 would carry forward.
Bottom Line
Tax-loss harvesting can reduce taxes, but only if you avoid wash sales and keep good records. Watch the 30-day before and after window, avoid substantially identical replacements, turn off reinvestment when needed, and remember that losses can carry forward if they exceed current-year limits.
Related Reading
- Capital Gains Tax 2026
- Qualified Dividends vs Ordinary Dividends
- VTI vs VOO vs VT in 2026
- Fractional Shares and Taxes
Sources
- IRS Publication 550, wash sales and investment income: https://www.irs.gov/publications/p550
- IRS Topic 409, capital gains and losses: https://www.irs.gov/taxtopics/tc409
- IRS Schedule D instructions: https://www.irs.gov/forms-pubs/about-schedule-d-form-1040