What is Tax-Loss Harvesting? Tax-Loss Harvesting is selling an investment at a loss to realize a capital loss for tax purposes, then reinvesting the proceeds in a similar (but not identical) asset, reducing your current tax bill without meaningfully changing your market exposure. It is one of the few “free lunches” available in a taxable brokerage account, most valuable during market downturns.
Worked example: you hold $50,000 in a total-market index fund that has dropped to $42,000, an $8,000 unrealized loss. You sell it and immediately buy a similar but not “substantially identical” fund (e.g. a different index provider tracking a comparable index), staying invested while realizing the $8,000 loss. That loss offsets $8,000 of capital gains elsewhere, or up to $3,000/year of ordinary income (US rule) with the remainder carried forward indefinitely.
| Realized loss | Offsets |
|---|---|
| Capital gains | Dollar for dollar, no limit |
| Ordinary income | Up to $3,000/year (US), excess carries forward |
The key restriction to know is the wash-sale rule (US-specific, check your local equivalent): buying back a “substantially identical” security within 30 days before or after the sale disallows the loss. This is why practitioners swap into a similar-but-different fund rather than repurchasing the exact same one. Rules and limits vary by country, verify current tax law before harvesting.