What is tax-loss harvesting? Rules and examples

Tax-loss harvesting is a complex, yet effective tax strategy that helps offset taxes on capital gains from other investments to reduce your overall tax burden. It can be a specific strategy that you aim to employ, or it can simply help soften the blow when you happen to lose money on investments. 

What are tax losses in investing?

You might think that it’s never great to lose money on an investment, but selling some at a loss each year can actually help your overall portfolio strategy, if you do it with planning and care. Tax losses are a term for when you sell an investment for less than your original purchase price. Those losses can be used to lower your tax burden on other gains you have made, and then reinvested into similar options. This process is called tax-loss harvesting, and it is one of many advanced investing strategies.  

Since tax-loss harvesting is a complex strategy and everyone’s goals are different, the information in this article, or any article for that matter, should not be taken as individual investment advice. Instead, use this information as a guide as you discuss your goals and needs with an experienced financial professional.

It’s also important to note that you cannot use tax-loss harvesting in most tax-advantaged accounts, like a 401(k) or IRA. The strategy is only applicable to investments held in taxable brokerage accounts. 

Benefits of a tax-loss harvesting strategy

The goal of tax-loss harvesting is to reduce your tax bill while maintaining a similar position in your investments. It can reduce taxes in the year you sell the investments and “realize” the loss and can even help you defer future taxes. It is not without risk, however. Like all investment strategies, there can be downsides. Tax-loss strategies are particularly susceptible to market-timing risks. 

Tax-loss harvesting explained

At its core, tax-loss harvesting helps defer some of the taxes you would pay on investment gains, essentially “kicking the can down the road.” This strategy attempts to help you save on taxes during your prime earning years when you are likely in a higher tax bracket, then realize greater gains once you’re in a lower tax bracket (such as during retirement). Here are the basic steps and how tax-loss harvesting works:

Realize investment losses
To ”realize” losses and take advantage of this strategy, you need to actually sell some investments for a loss. Unrealized capital gains and losses are treated differently. 

Offset capital gains
Any losses realized in the same year can offset other investments you have sold for a profit, reducing your tax liability on those gains. 

Offset ordinary income
If losses exceed total gains, you can use some of those losses to reduce your taxes on ordinary taxable income up to a specified amount each year, such as income from salary or wages.

Capital loss carryovers
If there is a particularly bad year in the market, you can carry over any net capital losses that exceed the annual deduction limit to offset gains in future years.  

Reinvest proceeds
The proceeds you make from the sale of an investment (even at a loss) and any tax savings from the process should be invested back in the market to maximize this strategy. Ideally, this should help you recapture the losses you originally experienced as the market or sector recovers. However, be mindful of the wash-sale rule defined below.   

The wash-sale rule

The main thing to look out for when planning to tax-loss harvest is the wash-sale rule. When you sell any investment for a loss, you cannot purchase the same or “substantially identical” investment or asset within 30 days before or after the sale or you can no longer claim the loss for tax purposes. This is to prevent investors from “gaming the system” to reduce their taxes while still retaining essentially the same investment position. 

Other tax-loss harvesting rules

In addition to the all-important wash-sale rule, there are other tax laws and codes at both the federal and state level that make tax-loss harvesting more complex. If you have significant investments, you might also be subject to net investment income tax (NIIT). For these reasons, you should always consult a tax and/or financial professional for individual investing advice.

Related: What is a fiduciary?

Short-term vs. long-term gains and losses

For proper tax-loss harvesting, you also need to understand the difference between short-term and long-term capital gains taxes, because they have different rates. When you sell an investment that you’ve owned for less than one year, it is considered short-term capital gains and taxed as ordinary income, which can be up to a 37% tax rate. If you hold on to the investment longer than one year, it’s considered a long-term investment and tax rates will usually be much lower, anywhere from 0% to 20% for federal taxes. When you utilize tax-loss harvesting, short-term losses are applied to short-term gains first and vice versa.

Tax-loss harvesting limits

There is no limit for tax-loss harvesting to offset capital gains in the same year. There is also no limit to the amount of losses you can carry forward into future years. There is, however, a limit to the capital losses you can use to offset your regular income each year. That limit in 2026 is $3,000 (or $1,500 if married filing separately).¹

Tax loss harvesting example

Let’s say you purchase 100 shares of investment A at $50 each, for a $5,000 cost basis. Later in the year, when investment A falls to $30 per share, you sell all 100 shares for $3,000, which locks in a $2,000 capital loss. In the same year, you made a $2,000 gain on investment B that you sold. The loss from A offsets the net gain from B entirely, so you owe no tax on those trades. In the 24% federal tax bracket, that $2,000 loss saved you $480 in taxes. With this strategy, you then want to reinvest the $3,000 proceeds + the $480 tax savings back into a similar (but not same or substantially identical) vehicle to investment A in order to recapture any recovery to that category or sector. Repeat this process as necessary and you are tax loss harvesting.  

Tax loss harvesting FAQs

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¹“Capital gains and losses” IRS, July 2025