Tax-Loss Harvesting Explained (and Who Should Actually Bother)
Turn paper losses into real tax savings. The rules, the wash sale trap, and when it's not worth it.
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Tax-loss harvesting is one of the few legal ways to turn a bad market into a tax refund. Sell something at a paper loss, buy a similar (not identical) replacement to stay invested, and use the realized loss to lower your tax bill. Done right it's worth hundreds to thousands a year. Done wrong it triggers the wash sale rule and accomplishes nothing.
How it works, mechanically
Say you bought $20,000 of VTI a year ago. It's now worth $17,000 — a $3,000 unrealized loss. Sell VTI and immediately buy $17,000 of ITOT (a near-identical total-market ETF from a different provider). You're still invested in essentially the same market exposure, but you now have a $3,000 realized loss on your tax return.
What the loss is worth
- Offset realized capital gains dollar-for-dollar (short-term gains first, then long-term).
- If losses exceed gains, up to $3,000 per year offsets ordinary income.
- Anything beyond $3,000 carries forward to future years — forever.
At a 32% federal + 9% state bracket, that $3,000 deduction is worth roughly $1,200 in actual tax saved. Multiplied across a bear market, the numbers add up.
The wash sale rule (the trap)
Buying the same or a 'substantially identical' security within 30 days before OR after the sale disqualifies the loss. The IRS isn't precise about 'substantially identical,' but the safe rules:
- Two ETFs from different providers tracking different indexes are fine (VTI → ITOT, VOO → SPLG).
- Two ETFs tracking the SAME index from different providers are a gray area — avoid.
- Buying in your IRA while selling at a loss in your taxable counts as a wash sale. Same household, same wallet.
- Spousal accounts count too.
The wash sale clock is 61 days wide: 30 days before, the sale day, and 30 days after. Mess this up and the loss is permanently deferred into the new lot's basis.
Common 'TLH pairs'
- VTI ↔ ITOT (total US market, different indexes)
- VOO ↔ SPLG (S&P 500 alternatives — gray area, prefer different index)
- VXUS ↔ IXUS (total international)
- BND ↔ AGG (total US bond market, different indexes)
When it's not worth it
- Tax-advantaged accounts (IRA, 401(k), HSA) — no benefit, losses don't pass through.
- Tiny balances or tiny losses — the bookkeeping and basis-tracking overhead isn't worth $50 saved.
- You're in the 0% long-term capital gains bracket — losses are wasted.
- Your replacement security is too 'similar' and you're not confident about the wash sale rule.
Automate it
Wealthfront and Betterment harvest losses daily inside taxable accounts and handle the wash sale logic automatically. For taxable accounts over ~$50k, the 0.25% fee is more than paid for by the TLH alone. If you're DIY, set a quarterly calendar reminder to scan for harvestable positions.
One subtle gotcha — basis matters
When you sell at a loss and rebuy, the new lot has a lower cost basis. You haven't escaped the tax — you've deferred it. The benefit is real (time value of money, the $3k ordinary income offset, possible step-up at death) but it isn't free money.
Frequently asked questions
Do robo-advisors do this automatically?+
Yes — Wealthfront and Betterment harvest losses daily and avoid wash sales across the accounts they manage. Worth the small fee for taxable accounts above ~$50k.
Can I harvest losses in my IRA?+
No — gains and losses inside tax-advantaged accounts don't flow through to your tax return.
What if I accidentally trigger a wash sale?+
The disallowed loss adds to the cost basis of the replacement shares — so you eventually get it back when you sell those. It's deferred, not destroyed.
Do dividends/DRIPs cause wash sales?+
Yes, technically — a dividend reinvestment within the 61-day window triggers a partial wash sale on those shares. Turn off DRIP when actively harvesting.
Is there a limit to how much I can harvest?+
No limit on the loss amount itself. The $3,000/year cap is only on offsetting ordinary income — losses against capital gains are unlimited.
Certified Financial Planner with 12 years guiding first-time investors.
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