What Is Tax-Loss Harvesting?
Tax-loss harvesting is the practice of intentionally realizing losses on investments to offset capital gains elsewhere in the portfolio (or up to $3,000 of ordinary income annually). The net effect: lower tax bill in the current year, with the original investment thesis preserved by buying a similar (but not substantially identical) replacement.
Common execution: sell a position at a $5,000 loss in December, immediately buy a different ETF in the same sector (e.g. sell VOO, buy IVV — both S&P 500 but distinct funds). The 30-day wash-sale rule prevents buying back the exact same security, but similar exposure is allowed.
Tax-loss harvesting can add 30-100 basis points to annual after-tax returns for active investors in higher tax brackets. Robo-advisors like Wealthfront and Betterment automate it. Most powerful in taxable brokerage accounts; irrelevant in IRAs and 401(k)s where capital gains aren't taxed annually.
Related terms
- Wash Sale — Tax rule disallowing the loss from a security sold and re-bought within 30 days.
- Risk Management — The systematic process of identifying and controlling exposure to losses.