Tax-Loss Harvesting: What to Know Before Selling Investments
Tax-loss harvesting can help reduce taxes on investment gains, but selling an investment at a loss is not automatically a smart financial decision. The potential tax benefit needs to be weighed against your overall investment strategy, current and future tax rates, and what you intend to do with the investment proceeds.
For people approaching or navigating retirement, these considerations can be particularly important. Changes in income, retirement withdrawals, and future financial goals can all influence whether harvesting a loss makes sense.
How Does Tax-Loss Harvesting Work?
Tax-loss harvesting involves selling an investment in a taxable account for less than its tax cost basis, creating a realized capital loss.
That loss can generally be used to offset realized capital gains. If your capital losses exceed your capital gains, you may be able to deduct up to $3,000 of the remaining net loss against ordinary income each year, or $1,500 if married filing separately. Unused capital losses can generally be carried forward to future tax years.
For example, suppose you sell an investment and realize a $15,000 capital gain. If you also sell another investment at a $10,000 loss, the loss may reduce your net taxable capital gain to $5,000.
That can create a tax benefit, but the value depends on your circumstances.
The IRS explains capital gains, losses, and carryovers in Publication 550.
1. Consider Your Current and Future Tax Rates
One of the most overlooked aspects of tax-loss harvesting is that the strategy often defers taxes rather than eliminating them.
If you sell an investment at a loss and purchase a replacement investment at a lower price, your new cost basis may also be lower. If the replacement appreciates and you eventually sell it, you could realize a larger taxable gain.
Whether that tradeoff is worthwhile depends partly on your tax rate today compared with the rate you might face in the future.
For example, someone approaching retirement may expect their taxable income to decline after leaving work. In that situation, realizing gains during a future year with a lower capital gains rate could be more attractive than using losses today.
In some circumstances, taxpayers may even qualify for a 0% federal long-term capital gains rate. Realizing gains within that bracket may be more beneficial than harvesting losses.
The important question is not simply how much tax you can save this year, but how the decision affects your taxes over time.
2. Coordinate Tax-Loss Harvesting with Your Retirement Plan
Capital gains and losses do not exist in isolation from the rest of your financial picture.
As you approach retirement, you may be evaluating Roth conversions, Social Security benefits, Medicare premiums, or withdrawals from taxable and retirement accounts.
Realized gains and losses can affect adjusted gross income and modified adjusted gross income, which are used in several tax and benefit calculations.
For example, investment gains can influence Medicare's income-related monthly adjustment amount, commonly called IRMAA. Harvesting losses may help offset some gains that would otherwise increase income used in the calculation.
However, the outcome depends on the specific income rules, timing, and other transactions involved.
If Medicare premiums are part of your planning, our article on how to appeal IRMAA explains another consideration when income changes around retirement.
Tax-loss harvesting may also be useful when rebalancing a portfolio or reducing an oversized investment position. Losses realized elsewhere in the portfolio may help offset gains from selling appreciated holdings.
The objective should be to improve the overall financial plan, not simply generate losses for tax purposes.
3. Be Careful of the Wash-Sale Rule
Tax-loss harvesting requires careful attention to the IRS wash-sale rule.
Generally, if you sell an investment at a loss and purchase the same or a substantially identical security within 30 days before or after the sale, the loss may be disallowed for current tax purposes.
The rule can apply even when the replacement purchase occurs in a different account, including certain transactions involving a spouse's account or an IRA.
Automatic dividend reinvestments and recurring investment purchases can also create unintended wash sales.
For example, selling shares of a mutual fund at a loss while an automatic reinvestment purchases additional shares of the same fund during the restricted period may cause part of the loss to be disallowed.
You can read the IRS explanation of wash sales in Publication 550.
If you want to remain invested after harvesting a loss, the replacement investment should be selected carefully. It needs to avoid wash-sale concerns while still fitting your desired asset allocation, diversification, and risk exposure.
4. Think About What You Ultimately Plan to Do with the Investment
Your long-term intentions for an investment can influence whether harvesting a loss is worthwhile.
If you expect to sell the investment during retirement, the tax implications of that future sale deserve consideration.
If you plan to leave appreciated investments to heirs, the potential adjustment to cost basis at death may affect the value of realizing losses today. Under current federal rules, many inherited assets receive a basis adjustment to fair market value at death, subject to applicable exceptions.
Gifting investments during your lifetime involves different rules. In particular, the recipient's basis can depend on whether the asset has appreciated or declined in value.
Charitable giving introduces another set of considerations. Donating appreciated securities directly to a qualified charity may provide different tax benefits than selling those investments first.
These decisions are closely connected to your estate and charitable giving plans. Tax-loss harvesting should be evaluated with those goals in mind.
5. Do Not Let Taxes Drive Your Investment Strategy
Tax-loss harvesting can be useful, but tax savings should not come at the expense of a well-designed portfolio.
Before selling an investment, consider whether the transaction changes your diversification, asset allocation, or exposure to particular market sectors.
Also account for trading costs, potential differences in performance between the original and replacement investments, and any state-specific tax rules.
Sometimes harvesting a loss makes sense because it supports a change you already wanted to make. Other times, holding the investment may be the better decision.
At SCM, we believe investment management and tax planning should work together to support your broader financial goals. A tax strategy is only valuable to the extent that it helps you make better decisions about your financial future.
Making Tax-Loss Harvesting Part of Your Financial Plan
Tax-loss harvesting is often discussed near year-end, but opportunities can arise whenever markets fluctuate.
The strategy is most effective when considered alongside your investment allocation, tax situation, retirement income needs, and long-term plans for your assets.
Rather than focusing only on this year's tax return, consider how today's decisions may affect your flexibility in retirement and your ability to use your financial resources for the life you want to live.
If you would like to discuss how tax-efficient investment management fits into your retirement strategy, we invite you to schedule a complimentary 15-minute call.
Frequently Asked Questions
Is tax-loss harvesting only useful at the end of the year?
No. Investment losses can be harvested throughout the year. Year-end is a common time to review realized gains and losses, but market volatility can create opportunities at other times.
Can I harvest losses in my IRA or 401(k)?
Tax-loss harvesting generally applies to investments held in taxable accounts. Selling an investment at a loss within a traditional IRA, Roth IRA, or 401(k) does not create a deductible capital loss.
How much capital loss can I deduct each year?
Capital losses can generally offset capital gains. If losses exceed gains, up to $3,000 of net capital losses may be deductible against ordinary income annually, or $1,500 if married filing separately. Remaining eligible losses can generally be carried forward.
Does tax-loss harvesting permanently reduce my taxes?
Not necessarily. The strategy often defers taxes because reinvesting at a lower cost basis may create larger taxable gains later. Its value depends on future tax rates, how long you hold the replacement investment, and what ultimately happens to the asset.
A Weekly Perspective on Planning and Markets
Each week, we share The Week in Review — a short collection of articles on
financial planning and wealth management, along with a brief overview for context.
One email per week. No promotions, no sales – just clarity.
This material was written in collaboration with artificial intelligence (ChatGPT) and derived from sources believed to be correct.
Stordahl Capital Management, Inc is a Registered Investment Adviser. This commentary is solely for informational purposes and reflects the personal opinions, viewpoints, and analyses of Stordahl Capital Management, Inc. and should not be regarded as a description of advisory services or performance returns of any SCM Clients. The views reflected in the commentary are subject to change at any time without notice. Nothing in this piece constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Advisory services are only offered to clients or prospective clients where Stordahl Capital Management and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Stordahl Capital Management unless a client service agreement is in place. Stordahl Capital Management, Inc provides links for your convenience to websites produced by other providers or industry-related material. Accessing websites through links directs you away from our website. Stordahl Capital Management is not responsible for errors or omissions in the material on third-party websites and does not necessarily approve of or endorse the information provided. Users who gain access to third-party websites may be subject to the copyright and other restrictions on use imposed by those providers and assume responsibility and risk from the use of those websites. Please note that trading instructions through email, fax, or voicemail will not be taken. Your identity and timely retrieval of instructions cannot be guaranteed. Stordahl Capital Management, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.