How Does Tax-Loss Harvesting Work?

Distinguish tax recognition from investment results

An unrealized loss is a decline relative to an investment's tax basis. Selling generally realizes it, but a deduction can be limited or disallowed. Selling at a loss inside an IRA or other tax-advantaged retirement account does not create the same personal capital-loss deduction. Tax-loss harvesting is a taxable-account strategy.

Capital losses and gains are netted under rules that distinguish short-term and long-term amounts. Remaining net losses may offset a limited amount of ordinary income, with excess carried forward under applicable rules. Confirm the current limit, filing status, and carryforward records rather than assuming the entire loss produces an immediate tax saving.

Check the full wash-sale window

The wash-sale rule generally disallows a loss on stock or securities when substantially identical stock or securities are purchased within 30 days before or 30 days after the loss sale. The review therefore begins before the sale date and extends afterward. Automatic purchases and dividend reinvestment can trigger issues even when there is no deliberate attempt to repurchase.

Look across accounts and include a spouse's purchases. A broker's tax report may not capture every transaction elsewhere. Purchasing substantially identical securities in your IRA or Roth IRA can also disallow a taxable-account loss; in that case, the usual taxable replacement-basis adjustment is not available, making the consequence particularly important.

Whether investments are substantially identical is a facts-and-circumstances tax question. Different names or tickers do not automatically establish a safe replacement. Consult a qualified tax professional rather than assuming two funds are acceptable substitutes simply because they have different issuers.

Keep the replacement investment appropriate

If you want to maintain market exposure, compare replacement holdings by strategy, diversification, liquidity, costs, and risks. They will not necessarily move identically to the investment sold. Avoid distorting the portfolio solely to create a tax loss, and do not treat the transaction as a promise to return to the original holding at a favorable price.

If you remain in cash during the waiting period, prices can move in either direction. Buying a replacement also involves market risk. Review spreads, transaction charges, restrictions, and the effect on allocation. A potential tax benefit can be outweighed by costs or an unsuitable investment change.

Understand future basis and taxes

Buying a replacement after a decline generally establishes a new tax basis at its purchase price. If that holding later rises and is sold, the lower basis can create a larger taxable gain. Tax-loss harvesting may shift the timing of taxes rather than eliminate them, and future rates and your future circumstances are uncertain.

For a wash sale involving a taxable replacement, a disallowed loss is generally added to the replacement's basis, with related holding-period rules. IRA replacement cases are different. Partial repurchases, multiple tax lots, and repeated trades complicate calculations, so keep complete records and review them with your preparer.

Before placing a trade

• Confirm the account is taxable, identify tax lots, and review existing gains and loss carryforwards.
• Check purchases during the preceding 30 days and planned purchases during the following 30 days across relevant accounts, including reinvestment and spouse or IRA activity.
• Evaluate the replacement's tax acceptability and investment role separately. Review costs and the effect on diversification.
• Coordinate with the tax preparer and retain records. A custodian's displayed tax estimate is not a complete household tax analysis.

Common tax-loss-harvesting questions