Tax-Loss Harvesting: How to Turn a Down Market Into Real Tax Savings

A down market is uncomfortable to live through, but it produces something valuable: realized losses. In a taxable brokerage account, those losses can be harvested (sold and reinvested in similar-but-not-identical securities) to generate capital-loss carryforwards that offset future gains and reduce current-year ordinary income. Done well, tax-loss harvesting (TLH) can lower a high earner's tax bill, and carried-forward losses don't expire during your lifetime.

This page is about the tax side of how we plan: where each dollar sits and when income lands. Tax-loss harvesting is often paired with Roth conversions to maximize the after-tax outcome.

What Tax-Loss Harvesting Is

The mechanic is simple. In a taxable brokerage account, when an investment is worth less than what you paid for it (your cost basis), you can sell it to "realize" the loss. The IRS treats that realized loss as a capital loss, which can:

1. Offset realized capital gains in the same year (dollar for dollar).
2. Offset up to $3,000 of ordinary income per year (e.g., wages, interest).
3. Carry forward indefinitely (for as long as you live) to future years if there are no current gains or ordinary income to offset.

The "harvesting" part is selling the loser, immediately buying a similar (but not "substantially identical") replacement, and keeping the same market exposure with a fresh, lower cost basis going forward.

This only works in taxable brokerage accounts. There is no benefit to harvesting in tax-deferred accounts (a 401(k) or a Traditional individual retirement account, known as an IRA) or Roth accounts; losses there have no tax consequence either way.

The Wash-Sale Rule (Don't Skip This)

The IRS won't let you sell at a loss and buy the same security back the next day to claim the tax benefit. That is a "wash sale." The rule:

If you sell a security at a loss and buy the "substantially identical" security within 30 days before or after the sale, the loss is disallowed for that year.

The disallowed loss gets added to the cost basis of the replacement security. The loss is deferred, so you can use it later, but the benefit for the current tax year is gone.

What counts as "substantially identical"?

• Same security, same CUSIP (the Committee on Uniform Securities Identification Procedures number that identifies each security): Wash sale. Selling a fund and buying the same fund back inside the window is the clearest possible violation.
• Different fund tracking the same index: This is where the room is. Two different providers' funds over very similar exposure carry different CUSIPs, and the IRS has not issued guidance treating different funds that track the same index as substantially identical. Which pairs are defensible, and which are close enough to invite a question, is the judgment call.
• The same stock in an IRA: Yes, this triggers wash sale. The IRS reads through account types. Don't sell Apple at a loss in your taxable account if your IRA buys Apple within 30 days.
• Spousal accounts: Treated as your accounts for wash-sale purposes.

The wash sale is the single most-violated rule in DIY tax-loss harvesting. The fix is to have a pre-decided replacement security ready before you harvest.

When Tax-Loss Harvesting Is Worth Doing

Not every loss is worth harvesting. The math depends on a few factors:

It is worth doing when:

• You are in a high marginal tax bracket (24%+), so each dollar of deduction is worth more.
• You have realized gains to offset, or you can use the $3,000/year ordinary-income offset.
• The loss is large enough that the tax savings exceed transaction costs and the friction of the trade.
• You have a clear "substantially not identical" replacement ready.
• You plan to give the position to charity or leave it to heirs. A position with a loss is usually worth selling first: donating it wastes the loss, and at death the basis steps down to market value, so the loss disappears.

It is not worth doing when:

• You are in a low bracket (0% long-term capital gains, or LTCG, rate) and have no expected high-bracket years ahead. Then realizing gains at 0% to reset your basis higher (gain harvesting) can be worth more than harvesting losses.
• The position is small (less than a few thousand dollars of loss). Transaction friction can eat the benefit.
• The investment is in a non-taxable account.

The $3,000 Ordinary-Income Offset

If your harvested losses exceed your realized gains, you can use the excess to offset up to $3,000 of ordinary income per year. At a 32% marginal bracket, that is $960/year of tax savings, every year, until the carryforward is exhausted.

For high earners with large harvested carryforwards from a 2022-style market drawdown, the $3,000 annual offset adds up: at a 32% bracket, that is roughly $9,600 over a decade. This is why carryforwards are valuable even when there are no current gains to offset.

Pairing TLH with Roth Conversions

This is the most powerful version of the strategy. The setup:

1. The market is down. You harvest losses in a taxable brokerage account: say, $80,000 of harvested losses on positions you immediately re-buy in similar-but-not-identical funds.
2. The same year, you execute a $50,000 Roth conversion from a Traditional IRA. The conversion is taxable as ordinary income.
3. The capital losses can offset realized capital gains; the $3,000 annual cap on ordinary-income offset still applies to the conversion. But if you also have realized gains elsewhere in the same year, the losses absorb those, and the Roth conversion happens "cheaper" against the rest of the tax picture.

The combined effect, assuming no other realized gains that year: you have converted $50,000 to Roth (taking advantage of the down market's lower share prices for the conversion), $3,000 of the losses has offset ordinary income, AND you have $77,000 of capital-loss carryforward sitting in your basis for future use. The down market produced both opportunities at once.

Pairing the two tools this way works better than using either one alone.

Direct Indexing: Tax-Loss Harvesting at Scale

For larger taxable accounts ($500k+), direct indexing (owning the individual stocks of an index instead of an index exchange-traded fund, or ETF) allows more frequent harvesting. The S&P 500 holds 500 stocks. In any given year, dozens of them are down even when the index is up. Direct indexing lets you harvest each one individually, generating losses even in years when an ETF holder would generate none.

The trade-offs: higher complexity, higher management cost (often via a separately managed account at 0.20% to 0.40%), and more tax-form pages. For accounts under $250k, the friction usually outweighs the harvest benefit.

How This Fits the Doctrine

Tax-loss harvesting is part of tax planning: where your dollars sit (taxable, tax-deferred, Roth) and how income is sequenced. Harvesting is one of the tools we use to keep that tax picture efficient year over year.

Paired with a Roth conversion, harvesting can produce a result neither move would produce alone.

Frequently Asked Questions

How often should I harvest?

Most pre-retiree taxable portfolios are reviewed quarterly for harvest opportunities. Some custodians and direct-indexing platforms run daily or weekly automated checks. The right cadence depends on portfolio size and volatility.

Can I harvest, then re-buy at year-end to lock in basis?

No, that's the wash-sale rule. Wait at least 31 days, or use a different fund.

Do I need to report harvesting on my taxes?

Yes. Realized losses show up on Schedule D and Form 8949. Your custodian sends a 1099-B detailing them. Carryforwards roll year-over-year via your return.

Does TLH work in retirement accounts?

No. There is no tax consequence to gains or losses inside a 401(k), Traditional IRA, or Roth IRA, so harvesting is meaningless. The strategy only applies to taxable brokerage accounts.

What about cryptocurrency?

Crypto positions can be harvested. The wash-sale rule, as written, covers stock and securities, and crypto held directly has been treated as property outside it, so you can technically sell bitcoin at a loss and re-buy immediately. Crypto exchange-traded funds are securities, so the rule does apply to them. Legislation to extend the wash-sale rule to crypto has been proposed multiple times, so verify current law before relying on it.

What to Do Next

What decides this for you. Whether you hold anything in a taxable brokerage account currently worth less than you paid for it. Harvesting only works there. A loss inside an IRA or a 401(k) buys you nothing, because those accounts were never going to be taxed on the gain in the first place. If everything you own sits in retirement accounts, this strategy is not available to you no matter how far markets fall.

Where it goes wrong. People sell the loser, buy something close enough back, and void the deduction they were trying to create. The window runs 30 days on both sides of the sale, and it reaches across accounts most people do not think of as connected: your spouse's, and your IRAs. The IRA version is the expensive one. In a normal wash sale the disallowed loss is added to the basis of the replacement shares, so you get it back eventually. When the repurchase happens inside an IRA, the loss is never added back, so it is gone for good.

Worth a conversation if you hold the same or similar funds in more than one account, you are weighing a Roth conversion in the same tax year, or you are carrying forward losses from a previous year and have lost track of how much. Those three cases are where sequencing decides the outcome, and where the order everything happens in separates a good harvest from an expensive one. Book a call and bring your last statement.

The information provided is for educational purposes only and does not constitute investment, legal, or tax advice. Tax law changes frequently, so verify current rules before acting. Consult with qualified professionals for guidance specific to your situation.