How to Use Tax-Loss Harvesting Without Making Mistakes

Learn tax-loss harvesting basics, avoid wash sale rules, and use this strategy without costly errors.

  1. Understand what tax-loss harvesting actually does. Tax-loss harvesting means selling investments that have lost value to create a capital loss on paper. You can use up to $3,000 of net capital losses per year to offset ordinary income, and any excess carries forward to future years. The goal is to lower your current tax bill while potentially buying back similar (but not identical) investments.
  2. Know the wash sale rule cold. You cannot buy the same or "substantially identical" security within 30 days before or after selling for a loss. This creates a 61-day window where the wash sale rule applies. If you violate this rule, the IRS disallows your loss deduction. The rule also applies to purchases in your spouse's accounts or retirement accounts.
  3. Identify your losing positions in taxable accounts only. Review your taxable investment accounts for positions trading below your purchase price. Only losses in taxable accounts count for tax-loss harvesting — losses in 401(k)s, IRAs, or other tax-advantaged accounts don't help. Focus on positions where you're down at least a few hundred dollars to make the effort worthwhile.
  4. Sell the losing investment and replace strategically. Sell your losing position and immediately buy a similar but not identical investment to maintain your market exposure. For example, if you sell one broad market index fund, buy a different broad market fund from another company. Wait at least 31 days before buying back the original investment if you want to.
  5. Track everything with detailed records. Keep records of every sale date, purchase date, dollar amounts, and which investments you bought as replacements. Your brokerage will send you tax forms, but you need your own records to ensure you don't accidentally trigger wash sales. Spreadsheets work fine for most people.
  6. Don't let the tax tail wag the investment dog. Only harvest losses on investments you were already planning to sell or rebalance. Don't sell good long-term investments just to get a tax deduction. The strategy works best when combined with regular portfolio rebalancing, not as a standalone tax scheme.