Tax-Loss Harvesting: Year-End Strategy

When investments lose value, you have the opportunity to turn that loss into a tax benefit. Tax-loss harvesting lets you sell investments at a loss, use those losses to offset gains and income, and potentially lower your tax bill. While this can be done year-round, year-end is a natural time to review and execute.

How Tax-Loss Harvesting Works

The core concept is straightforward. Sell an investment that's worth less than what you paid. The loss is realized and can offset other gains on your tax return.

If you have $10,000 in capital gains from winning investments and $4,000 in losses from selling losers, you only pay tax on $6,000 of net gains.

If your losses exceed your gains, you can use up to $3,000 of net capital losses to reduce ordinary income each year. Excess losses carry forward to future years indefinitely.

Short-Term vs. Long-Term Losses

Like gains, losses are categorized as short-term (held one year or less) or long-term (held more than one year).

Short-term losses first offset short-term gains. Long-term losses first offset long-term gains. Then remaining losses of one type offset the other.

Since short-term gains are taxed at higher ordinary income rates, short-term losses are particularly valuable for offsetting them.

The Wash Sale Rule

The IRS doesn't let you claim a loss if you buy back the same or substantially identical investment within 30 days before or after the sale. This is the wash sale rule.

If you sell shares of ABC Company at a loss on December 15 and buy ABC shares back on December 30, you can't claim the loss. The rule exists to prevent people from harvesting losses while essentially maintaining their position.

The workaround: either wait 31 days to repurchase, or buy a similar but not identical investment immediately. Selling an S&P 500 index fund and buying a different company's total market index fund is generally acceptable. Selling shares of Apple and buying them back is not.

Year-End Timing

To claim losses for the current tax year, the sale must settle by December 31. Stock trades typically settle in one business day (T+1). To be safe, execute trades by December 27 or earlier to account for any holiday closures.

Late December is a natural review point. You know your income for the year. You can see which positions are underwater. You can calculate how much loss harvesting would benefit your tax situation.

What to Harvest

Good candidates for loss harvesting:

Positions with meaningful losses. Small losses aren't worth the effort.

Investments you're comfortable selling. If you still want the position, you'll need to find a substitute or wait 31 days.

Investments that don't fit your strategy anymore. Losses on positions you'd sell anyway are free tax benefits.

Poor candidates:

Investments with tiny losses. The tax benefit is minimal and not worth the transaction costs or hassle.

Positions you're convinced will rebound quickly. Selling triggers the loss but may mean missing the recovery.

Staying Invested

You don't have to exit the market when loss harvesting. Sell the losing investment and immediately buy a similar one.

Sell S&P 500 fund, buy total market fund. Sell one large-cap growth ETF, buy a different large-cap growth ETF. The key is avoiding substantially identical investments while maintaining your overall market exposure.

After 31 days, you can switch back to your original investment if you prefer.

Record Keeping

Track your cost basis carefully. When you sell and rebuy similar investments, your basis changes. When you have wash sales, the disallowed loss adds to the basis of the replacement shares.

Brokers often handle this tracking, but not always perfectly. Keep your own records of purchase dates, prices, and any wash sale adjustments.

When Not to Harvest

If you're in a low tax bracket and expect to be in a higher one later, harvesting losses now might not make sense. You'd be reducing taxable income at a low rate when you could use those losses to offset income at a higher rate in the future.

If an investment has small unrealized losses and high potential, selling to harvest a modest loss might not be worth missing possible gains.

If transaction costs or complexity outweigh the tax benefit, skip it.

This article is for educational purposes only and does not constitute tax advice. Consult a qualified tax professional for guidance specific to your situation.