For investors in the United States, minimizing taxes is as crucial as maximizing returns.
One highly effective strategy for reducing tax liabilities is tax-loss harvesting. This method allows investors to strategically sell investments at a loss to offset gains elsewhere in their portfolios, potentially lowering their overall tax burden.
While many investors think of tax-loss harvesting as a year-end tactic, it can actually be employed throughout the year, particularly during periods of market volatility. According to the IRS, investors can use realized capital losses to offset both capital gains and up to $3,000 of ordinary income annually, with any remaining losses carried forward to future years. This makes tax-loss harvesting a flexible tool for optimizing investment returns and tax efficiency.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is a method of selling securities that have declined in value to realize a capital loss, which can then offset realized capital gains elsewhere in the portfolio. For example, if an investor sells Stock A for a $30,000 gain and sells Stock B for a $15,000 loss, the net taxable gain is reduced to $15,000. This strategic use of losses allows investors to keep more of their returns while still maintaining their investment allocations.
Moreover, any excess losses beyond capital gains can offset up to $3,000 of ordinary income each year, with additional losses carried forward to future tax years. This strategy can significantly reduce an investor’s tax liability, particularly for those in higher income brackets who face steep capital gains rates.
How Tax-Loss Harvesting Works
The process involves identifying underperforming securities in a portfolio and selling them to realize a loss. These losses can then offset realized gains from other investments. To maintain the portfolio’s desired asset allocation, proceeds from the sale are often reinvested in similar, but not identical, securities. This approach allows investors to remain exposed to potential market growth while leveraging the tax benefits of the loss.
A critical consideration is the wash sale rule, which disallows claiming a loss if the same or substantially identical security is repurchased within 30 days before or after the sale. By carefully selecting replacement investments—such as similar stocks within the same industry—investors can adhere to the IRS rules while staying invested in the market.
Short-Term vs. Long-Term Gains
Tax-loss harvesting is particularly impactful for investors dealing with short-term gains, which are taxed at ordinary income rates that can reach up to 37% in 2025 (IRS, 2025). In contrast, long-term capital gains, from investments held longer than a year, are taxed at preferential rates of 0%, 15%, or 20%, depending on income levels.
By strategically using losses to offset short-term gains, investors can reduce taxes on the portion of their portfolio that is otherwise taxed at higher rates. For investors with frequent trading activity or high-turnover strategies, the ability to manage short-term gains through tax-loss harvesting can make a substantial difference in after-tax returns.
Tax-loss harvesting “harvests” investment losses, similar to how crops are harvested, to offset gains and reduce taxes.
Example Scenario
Consider an investor who sold Fund X for a $30,000 gain but owns Fund Y, currently down $33,000. By selling Fund Y, the investor can offset the $30,000 gain entirely and still apply $3,000 of the remaining loss against ordinary income, reducing taxable income for the year. Any remaining loss can be carried forward to future tax years, providing continued tax benefits.
This strategy illustrates how losses that might initially feel like setbacks can be converted into tangible tax savings, effectively turning market downturns into opportunities for portfolio optimization.
Year-Round Benefits
Although tax-loss harvesting is commonly associated with year-end tax planning, it can be beneficial year-round. During periods of market volatility, investors can strategically realize losses whenever opportunities arise, enhancing overall tax efficiency. Morgan Stanley notes that using tax-aware strategies in conjunction with financial advisory services can help investors integrate tax-loss harvesting into their broader investment plan while managing risk.
People Also Ask
How much ordinary income can tax-loss harvesting offset in 2025?
Investors can offset up to $3,000 of ordinary income per year using net capital losses, with any remaining losses carried forward to future tax years.
Can tax-loss harvesting be done on cryptocurrency?
Yes, cryptocurrency is treated as property by the IRS, so selling digital assets at a loss can offset capital gains, similar to stocks and mutual funds.
What is the wash sale rule?
The wash sale rule prevents claiming a loss if the same or substantially identical security is repurchased within 30 days before or after the sale. Losses must be deferred in this scenario.
Can tax-loss harvesting be applied to retirement accounts like IRAs or 401(k)s?
No, tax-loss harvesting is generally not allowed in tax-advantaged retirement accounts such as IRAs and 401(k)s because gains and losses in these accounts are not taxed annually. The strategy is most effective in taxable brokerage accounts.
Key Considerations
While tax-loss harvesting can reduce taxes and increase after-tax returns, it’s not a one-size-fits-all solution. Investors must be mindful of portfolio allocation, investment objectives, and the IRS rules regarding wash sales and short-term versus long-term gains. Overemphasis on tax-loss harvesting without considering overall investment goals can lead to under-diversified portfolios or missed growth opportunities.
For those with complex portfolios or significant capital gains, working with a financial advisor or tax professional is recommended. Advisors can ensure that tax-loss harvesting strategies are implemented effectively, compliance is maintained, and opportunities for long-term growth are not compromised.
Conclusion
Tax-loss harvesting is a valuable strategy for U.S. investors seeking to minimize taxes on investment gains. By realizing losses strategically, investors can offset gains, reduce ordinary income, and carry forward excess losses, enhancing overall portfolio efficiency. With proper planning, adherence to IRS rules, and the guidance of financial professionals, tax-loss harvesting can turn market downturns into a long-term advantage.
While there is no guarantee of specific tax savings, when implemented thoughtfully, this strategy provides a legally compliant method to improve after-tax returns and preserve wealth in a tax-efficient manner.
