Tax-Loss Harvesting: How It Actually Works (and When It's Not Worth Bothering)
Selling losing investments to lower your tax bill sounds clever. In practice, it only matters for a specific set of investors — and is overhyped for everyone else.
Tax-loss harvesting is one of those concepts that financial media loves because it sounds sophisticated, and brokerages love because it gives them something to upsell. The actual mechanic is simple, the actual benefit is real but limited, and the actual relevance to most investors is much smaller than the marketing suggests.
The basic mechanic
When you sell an investment at a loss in a taxable brokerage account, you "realize" that loss. Realized losses can offset realized gains, dollar for dollar. If your losses exceed your gains, you can use up to $3,000 of the excess to offset ordinary income each year, and carry the rest forward indefinitely.
A concrete example
You bought $20,000 of an S&P 500 ETF a year ago. It is now worth $17,000 — a $3,000 unrealized loss. You sell it, realize the $3,000 loss, and immediately buy $17,000 of a different total-market ETF that tracks a different index. At a 24% marginal tax rate, you saved $720 in federal tax.
The wash-sale rule
The IRS will disallow the loss if you buy back the same security — or a "substantially identical" one — within 30 days before or after the sale. You cannot sell SPY at a loss and buy VOO 20 days later; both track the S&P 500.
Why the benefit is smaller than it looks
Tax-loss harvesting does not eliminate tax. It defers it. When you eventually sell the replacement security, your cost basis is the lower purchase price, so you have a larger gain. The benefit is the time value of money.
When it actually matters
- You have a large taxable brokerage account ($100,000+).
- You have realized gains in the same year that the losses can offset.
- You are in a high marginal tax bracket (24%+).
- You plan to eventually be in a lower bracket.
When it does not matter much
- All your investments are in a 401(k) or IRA. Tax-loss harvesting is meaningless there.
- Your taxable account is small (under $25,000).
- You are likely to be in the same or higher tax bracket in retirement.
Tax-loss harvesting is a real tool. It is also the most over-sold tool in retail investing — useful at scale, mostly noise below it.