How does tax-loss harvesting work and what is the wash sale rule?

Tax-loss harvesting is the strategy of selling investments at a loss to offset capital gains and reduce your tax bill. It's one of the most effective legal tax reduction strategies for investors.

How it works:

• You sell an investment that has declined in value, realizing a capital loss
• The loss offsets your capital gains dollar-for-dollar (short-term losses offset short-term gains first, then long-term gains, and vice versa)
• If losses exceed gains, you can deduct up to $3,000 ($1,500 if MFS) against ordinary income per year
• Unused losses carry forward indefinitely to future tax years

Example: You have $10,000 in capital gains from selling stock. You also hold another stock with a $7,000 unrealized loss. By selling the losing position, you reduce your taxable gain to $3,000, saving $1,050 at the 15% long-term rate.

The Wash Sale Rule (IRS Section 1091):

The IRS prevents you from claiming a loss if you buy a "substantially identical" security within 30 days before or after the sale (a 61-day window total). If triggered:

• The loss is disallowed for the current tax year
• The disallowed loss is added to the cost basis of the replacement shares
• Your holding period of the original shares carries over

What triggers a wash sale:

• Buying the same stock/ETF within the 30-day window
• Buying it in a different account (including IRA — this is a common mistake!)
• Buying a substantially identical mutual fund or ETF
• Acquiring shares through dividend reinvestment (DRIP)

What does NOT trigger a wash sale:

• Selling a total U.S. stock market ETF (VTI) and buying an S&P 500 ETF (VOO) — these are not substantially identical despite overlap
• Selling one company's stock and buying a different company's stock
• Waiting 31+ days to repurchase the same security

Best practices:

• Harvest losses throughout the year, not just in December
• Replace the sold position with a similar (but not identical) investment to maintain market exposure
• Track your transactions carefully across ALL accounts
• Consider the long-term benefit: deferring gains through harvesting means more money stays invested and compounding