Tax-Loss Harvesting

In many tax systems, realized capital losses can reduce realized capital gains. Tax-loss harvesting deliberately realizes losses to use this rule.

For example, an investor has realized gains of 5,000 this year from selling one fund. Another investment is showing a loss of 3,000. Selling it realizes the loss, so the taxable gain falls to 2,000. The investor can then reinvest the proceeds in a similar, but not identical, investment to keep their market exposure.

The strategy defers tax rather than eliminating it in many cases. Buying a replacement investment at a lower price means a lower cost basis, so a larger gain may be taxed when it is eventually sold. The benefit is greatest when tax can be deferred for many years, or when losses offset gains taxed at high rates.

Rules limit the strategy. In the United States, the wash-sale rule disallows a loss if the same or a substantially identical investment is bought within 30 days before or after the sale. The United Kingdom has a similar 30-day rule. Harvesting is only useful in taxable accounts, not in tax-advantaged ones.