Tax Loss Harvesting and Wash Sale Rules: Saving Taxes on Your Investments

Investors often face ups and downs in the market, but even losing trades can be valuable. When you sell a losing investment, you can use that loss to offset gains and reduce taxes. As Charles Schwab notes, “getting a tax break when you sell a losing investment – better known as tax-loss harvesting – is one of the few upsides of dumping an underperforming asset” . In practice, tax-loss harvesting means selling securities at a loss to offset capital gains or income, thereby lowering your overall tax bill. For example, if you made a $10,000 gain on one stock and a $7,000 loss on another, your net taxable gain is only $3,000 (not $10,000). That $7,000 loss can eliminate the tax on much of the gain.

Tax-loss harvesting is a powerful, tried-and-true strategy for lowering taxes. You can use realized losses to offset capital gains dollar-for-dollar, and if your losses exceed gains, you can deduct up to $3,000 of the excess against ordinary income each year. The IRS also lets you carry forward any unused losses to future years. In fact, Vanguard explains that if “your capital losses exceed your capital gains, you can reduce your taxable income by up to $3,000 for the year” and carry over the rest. Over time, these tax savings can compound – reinvest the money you save to grow your portfolio further.

How Tax-Loss Harvesting Works

Tax-loss harvesting typically happens in taxable accounts (brokerage or investment accounts, not retirement accounts). It works like this: if you have capital gains, you intentionally sell some investments that are at a loss. This creates a paper loss you can claim on your tax return. You then reinvest the proceeds in a similar asset (so you stay invested in the market). Vanguard emphasizes that after selling at a loss, “you take the money from the sale and use it to buy an investment that fills a similar role in your portfolio, so you stay invested in the market”. In other words, you don’t want to sit in cash and miss out on rebounds; you just replace the sold asset with another that matches your long-term plan.

The key benefit is that your realized losses offset realized gains. For example, say you sell Stock A for a $7,000 gain, and you sell Stock B at a $4,000 loss. Your net capital gain is now $3,000 (instead of $7,000). If you were otherwise taxed at 15%, that $4,000 loss saved you $600 in taxes on the sale of Stock A. And because investment returns are long-term in nature, that extra $600 can be reinvested (and potentially grow) rather than sent to the IRS.

If you have more losses than gains in a year, you can deduct up to $3,000 of the excess loss against your ordinary income. For example, if you ended up with $10,000 of net capital losses and no gains, you could use $3,000 of that to reduce your salary or other income this year, and carry the remaining $7,000 forward to use in future years. This limit is per return (so $1,500 per spouse if filing separately), but any leftover losses keep rolling over until fully used.

Important: Tax-loss harvesting only works in taxable accounts. You cannot use losses in an IRA or 401(k) the same way, because those accounts are tax-advantaged and gains/losses aren’t reported the same way. In fact, Thrivent and TurboTax both warn that this strategy “doesn’t apply to tax-advantaged retirement accounts” – the gains and losses in IRAs or 401(k)s are not realized until withdrawal. So any selling within a retirement account won’t generate a deductible loss, and if you try to harvest by buying the same stock in an IRA after a sale, you actually trigger the wash-sale rule (discussed below). Always keep your tax-loss harvesting transactions in a regular taxable brokerage account.

The Wash-Sale Rule

The one big catch to tax-loss harvesting is the IRS wash-sale rule . This rule is designed to prevent investors from simply selling a security at a loss and immediately buying it back just to claim a tax write-off. In plain language: if you sell a stock or fund for a loss and then repurchase the same or a substantially identical security within 30 days (before or after the sale), the IRS will disallow that loss. In other words, you cannot claim the deduction for that loss on your tax return. (The period is effectively 61 days long – 30 days before and 30 days after the sale date.)

For example, Schwab explains this scenario: suppose you bought 100 shares of XYZ stock for $1,000 total, and later sell them for $800 (a $200 loss). If you then repurchase 100 shares of XYZ three weeks later for $600, you trigger a wash sale. The IRS disallows the $200 loss on this year’s tax return. Instead, that $200 is added to your cost basis in the new shares. So your $600 purchase is re‐basised to $800. Effectively, you still get the benefit – your future gains will be $200 smaller – but you don’t get the tax deduction right away.

Put simply: Don’t buy back the same security too soon. If you violate the rule, “the loss cannot be used to offset gains or reduce taxable income”. Vanguard also warns that if you buy any “substantially identical” investment within 30 days, you won’t be able to claim the loss. The IRS even extends this across accounts: buying the same stock in an IRA or your spouse’s account still counts as a wash sale. For example, selling Stock A at a loss in your brokerage and then buying Stock A in your IRA 10 days later would trigger the rule.

Practical Tips and Pitfalls

To avoid wash-sale pitfalls, follow a few simple guidelines:

• Wait 31+ Days: If you want to rebuy the same investment, wait at least 31 days after the sale. This meets the IRS 30-day window and makes the loss valid.

• Use Similar (Not Identical) Securities: You can stay invested by buying a different fund or ETF with similar exposure. For instance, you might sell an S&P 500 index fund at a loss and immediately buy a Russell 1000 index fund instead. Schwab gives this exact example: selling an S&P 500 tracker and buying a “not substantially identical” large-cap index like the Russell 1000 preserves your market exposure without triggering a wash sale.

• Track Across Accounts: Remember that the wash-sale rule applies across all your accounts, not just the one where you sold the stock. If you buy the same security in any of your other taxable or tax-deferred accounts (or your spouse’s accounts) within 30 days, it still triggers the rule. It’s your responsibility to coordinate trades across accounts.

• Record the Transactions: Keep detailed records of all buys and sells with dates. Tax software and brokers usually flag wash sales, but mistakes happen. Careful tracking ensures you don’t accidentally double-count a loss.

By carefully following these practices, you can harvest tax losses effectively without running afoul of IRS rules. It’s often said that “the wash sale rule prevents investors from ‘manufacturing’ tax losses” – meaning you shouldn’t buy back a loser too fast just to claim the deduction. Instead, use legitimate strategies (like similar replacements or time delays) to keep your plan on track.

Why Work With a Tax Professional

Tax-loss harvesting can be a great way to cut your tax bill, but it involves detailed timing and rules. The IRS rulings about “substantially identical” securities and 30-day windows can be complex. Even savvy investors can make mistakes that cost them money. As Vanguard notes, this strategy is complex and it’s wise to “consult with your financial advisor or tax professional” to make sure you’re complying with all rules. Likewise, TurboTax explicitly points out that TLH “works on taxable investments and doesn’t work with tax-deferred retirement accounts” – so professional advice helps you apply it correctly.

At Brister Law Firm, we help clients navigate these details and avoid costly missteps. For example, we can review your year-end portfolio, identify which positions to sell for maximum tax benefit, and structure any trades so you don’t accidentally trigger a wash sale. We stay on top of IRS guidance (like Revenue Ruling 2008-5) and coordinate between multiple accounts if needed. Our goal is to help you keep more of your hard-earned gains and ensure compliance with all federal regulations [Internal Link: Advanced Tax Planning]. As one guide suggests, when in doubt, “consult a tax professional to ensure all tax strategies are being maximized for you”. We can assist with that.

In summary, tax-loss harvesting can turn paper losses into real tax savings. By selling underperforming investments, you can offset gains, up to $3,000 against ordinary income each year, and carry forward the rest. Just be mindful of the wash-sale rule: don’t repurchase the same asset within 30 days or your deduction vanishes. Used correctly, it’s a powerful strategy for investors of all income levels. If you’re unsure how to implement it – or if you’ve been hit by a wash sale inadvertently – reach out. We’re here to help you save on taxes and protect your investments every step of the way.

Key Takeaways:

• Sell losing investments to offset gains and reduce capital gains tax [Internal Link: Capital Gains Blog].

• Excess losses can offset up to $3,000 of ordinary income per year; unused losses carry forward.

• The IRS wash-sale rule disallows losses if you buy the same (or substantially identical) security within 30 days.

• Harvesting only applies in taxable accounts (not IRAs/401(k)s).

• Tax professionals like Anthony Brister can help you plan and execute these strategies correctly to avoid pitfalls.