How To Use Tax-Loss Harvesting To Offset Capital Gains

Tax-loss harvesting offsets capital gains by selling investments that have lost value to realize a loss, which directly cancels out your realized capital gains dollar-for-dollar, and up to $3,000 of ordinary income if losses exceed gains.

How Tax-Loss Harvesting Matches Losses to Gains

Start by pulling your year-to-date realized gains from your brokerage’s tax center or trade confirmations. These are sales you’ve already executed at a profit. Next, list every open position in your account that is currently underwater. That means its market price is below what you paid, your cost basis. For each losing position, calculate the unrealized loss as: (current market price, cost basis) × number of shares. Add up those losses, then compare the total to your realized gains. You want to sell only enough losing shares to match your gains exactly. Any excess loss beyond your gains can offset up to $3,000 of ordinary income, like salary or interest, this year. The remainder carries forward to future years indefinitely. The Internal Revenue Service sets the $3,000 ordinary-income offset cap. Confirm the current figure on the official IRS website. Execute the sale on a trading day when the market is open. Confirm the trade settles by December 31. Settlement typically takes two business days, so place the order no later than December 29 for 2025. If you have multiple lots of the same security, use the specific identification method. When you place the sell order, instruct your broker to sell the lots with the highest cost basis first. This maximizes the realized loss per share sold.

The Wash Sale Trap

The IRS disallows the loss if you buy a “substantially identical” security within 30 days before or after the sale. This is the wash sale rule. It applies across all your accounts, including IRAs and 401(k)s, not just the taxable account where you sold. For example, you sell 100 shares of VTI at a $2,000 loss on December 20. Then you buy 100 shares of VTI on January 5, 16 days later. The loss is permanently disallowed. Your new shares’ cost basis is increased by $2,000, so you’ll pay more tax when you eventually sell. The rule also triggers if you reinvest dividends automatically. If your brokerage reinvests a VTI dividend into new shares within the 30-day window, that counts as a purchase. To avoid the trap, either wait 31 days before repurchasing the same security, or buy a similar but not “substantially identical” fund. For instance, swap VTI for ITOT, a different total market ETF, or sell a specific stock and buy a sector ETF. Be especially careful with tax-advantaged accounts. If you sell at a loss in your taxable account and buy the same stock in your IRA within 30 days, the loss is still disallowed. The IRA’s cost basis is not adjusted. You permanently lose that deduction. For guidance on how different account types interact with your overall strategy, the hub for this topic is Retirement & Investment Taxes: What to Know and How to Handle It, which covers the full picture of taxable vs. tax-deferred holdings.

When Tax-Loss Harvesting Backfires

Harvesting can hurt you if you repurchase the same security after the 30-day window but at a much lower price. You’ve locked in a loss now, but your new cost basis is lower. Your future gain when you sell will be larger. This could push you into a higher capital gains bracket. The 15% rate could become 20%, plus the 3.8% Net Investment Income Tax if your adjusted gross income exceeds the thresholds set by Congress. For single filers, the income threshold is $200,000. For married couples filing jointly, the threshold is $250,000. Verify these AGI limits on the official IRS website. Another risk: if you harvest losses in a year when you have no capital gains, you might waste the $3,000 ordinary income offset. This happens if you don’t have enough income to use it, unlikely for most, but possible for retirees with low income. State tax rules can also complicate things. Most states follow federal rules, but a handful, like California, do not allow carryforward of losses. A loss harvested now might never offset state income. Finally, avoid harvesting in December if you’re planning to sell a winner in January. You’d be better off taking the gain in the same year as the loss to net them against each other, rather than carrying the loss forward. The related article on use tax-loss harvesting to offset capital gains dives deeper into advanced scenarios, but the core rule is: only harvest if the loss is economically motivated, not just to defer tax. For example, you’re considering selling a losing stock to offset a gain from selling your rental property. Check whether your state treats that loss the same way. Some states disallow losses on sales to related parties, like your spouse’s IRA. Also, remember that the wash sale rule applies to your spouse’s trades too. Coordinate with them before December. If you’re retired, be careful about harvesting losses in a year when you’re also making Roth conversions. The loss reduces your AGI, which could push you into a lower tax bracket for the conversion. It also reduces your Medicare premium surcharges, IRMAA, if you’re over 65, which is a hidden benefit. A separate question many investors ask is whether are traditional IRA contributions and withdrawals taxed differently from brokerage gains. Yes, they are. That distinction matters when deciding whether to harvest in a taxable account at all.

Frequently Asked Questions

What happens if I sell a losing stock and buy a call option on the same company within 30 days?

That counts as a wash sale if the option is “substantially identical” to the stock. Typically, deep-in-the-money calls with a near-term expiration are treated as such. The loss is disallowed, and the option’s cost basis is increased by the disallowed amount.

Can I harvest losses in a mutual fund that I’ve held for less than a year?

Yes, but the loss will be short-term. Short-term losses offset short-term gains first, which are taxed at ordinary rates up to 37%. If you have no short-term gains, the short-term loss offsets long-term gains. But you lose the preferential rate on those gains.

Do I need to report tax-loss harvesting on my tax return if I don’t owe any tax?

Yes, you must file Schedule D and Form 8949 to report all sales, even if the net result is a loss. The loss carries forward via Schedule D, line 16, and you’ll use it in future years.

Is there a limit on how much I can harvest in one year?

No, there’s no dollar limit on the losses you can realize. But the $3,000 ordinary income offset cap applies per year. The Internal Revenue Service sets this cap. Confirm the current limit on the official IRS website. Any excess loss beyond that carries forward as a long-term or short-term loss, depending on the holding period. For a deeper dive into how these rules fit with your overall financial picture, see the broader topic of retirement & investment taxes in Retirement & Investment Taxes: What to Know and How to Handle It.