Tax-Loss Harvesting: A Practical Way to Reduce Investment Taxes
- Christian Wolff
- 3 days ago
- 3 min read
Most investors focus on how much their portfolio grows. Far fewer focus on how much of that growth they actually keep after taxes. Over time, taxes can quietly reduce investment results, especially in taxable accounts. Tax-loss harvesting is one way investors can actively manage that tax impact without changing their long-term investment approach.
The Basic Idea
Tax-loss harvesting involves intentionally selling an investment that has declined in value in order to realize a capital loss. That loss can then be used to reduce taxes owed on other investment gains or, in some cases, on ordinary income. In many situations, the proceeds from the sale are reinvested into a similar investment so the portfolio remains aligned with its overall strategy. This is what separates tax-loss harvesting from market timing—it is a tax decision, not a prediction about future performance.
How Losses Are Used on a Tax Return
When capital losses are realized, they are first applied against capital gains. Only the net result matters for tax purposes. If losses exceed gains for the year, a portion of the excess loss—up to $3,000—can be used to reduce ordinary income. Any remaining losses are carried forward and may be used in future years. This means losses realized today can provide tax benefits long after the original investment has recovered or been replaced.
Why Investors Consider Tax-Loss Harvesting
Tax-loss harvesting can create flexibility within a portfolio. It allows investors to rebalance, reduce risk, or move away from inefficient investments while softening the tax impact of those decisions. By lowering current tax liability, more capital stays invested, which can improve long-term after-tax results. Market volatility, while uncomfortable, can also create opportunities to realize losses that may not exist in steadily rising markets.
The Wash-Sale Rule
One of the most important considerations in tax-loss harvesting is the IRS wash-sale rule. This rule disallows a loss if the same or a substantially identical investment is purchased within 30 days before or after the sale. Accidentally triggering a wash sale can eliminate the intended tax benefit, which is why coordination across accounts and careful timing are essential when implementing this strategy.
A Simple Example
Consider an investor who sells one investment during the year and realizes $20,000 in long-term capital gains. Later in the year, the investor sells another investment that has declined in value and realizes a $28,000 capital loss.
The $28,000 loss first offsets the $20,000 gain, reducing taxable capital gains to zero and eliminating any capital gains tax for the year. The remaining $8,000 net loss can then be applied further. Under current tax rules, $3,000 of that loss may be used to reduce ordinary income, such as wages or interest income, in the same year. The remaining $5,000 is carried forward and can be used to offset gains or income in future tax years.
When Tax-Loss Harvesting May Not Make Sense
Tax-loss harvesting is not always beneficial. Future tax rates, transaction costs, investment time horizon, and overall tax situation all play a role. In some cases, realizing a loss today may simply defer taxes rather than reduce them. For this reason, the strategy is most effective when used as part of a broader tax and investment plan rather than in isolation.
Final Thoughts
Markets will rise and fall, but taxes are one of the few variables investors can actively manage. Tax-loss harvesting provides a way to respond to market declines with intention, turning losses into a potential long-term advantage. When used thoughtfully, it can improve tax efficiency without compromising investment discipline.
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The information provided in this blog post is intended for general informational purposes only and should not be construed as legal or tax advice. While every effort has been made to ensure the accuracy of the information, tax laws and regulations are subject to change, and individual circumstances may vary. For personalized advice and to ensure compliance with current tax laws, it is strongly recommended that you consult with a qualified tax professional, financial advisor, or legal counsel. The author and publisher of this blog assume no responsibility for any errors or omissions, or for any actions taken based on the information contained herein.
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