Tax Loss Harvesting? Money $$$ to be saved before 12/31
While you cannot control market returns, you can control how much of those returns you hand over to the IRS.
Most investors simply pay their tax bill and move on. However, sophisticated investors utilize a strategy known as Tax-Loss Harvesting.
What Is Tax-Loss Harvesting?
It's simpler than it sounds.
When an investment drops below what you paid for it, you can sell it, lock in that "loss" on paper, and use it to lower your tax bill.
The best part? You immediately reinvest in something similar—so your portfolio stays on track. You're not sitting on the sidelines. You're just swapping one investment for another while pocketing a tax benefit.
Think of it like returning a sweater that went on sale and buying an almost identical one for the same price. You still have a sweater. But now you also have store credit.
Who Should Use Tax-Loss Harvesting?
This strategy only works in taxable brokerage accounts.
It doesn't apply to IRAs, 401(k)s, or other retirement accounts—because gains and losses in those accounts aren't taxable events anyway.
If you have a taxable investment account and a long time horizon, tax-loss harvesting is one of the few reliable ways to boost your after-tax returns.
Why Could This Work? Different treatments in US tax code
The US tax code does not treat all investment gains equally. This disparity between short-term and long-term capital gain is the engine that makes Tax-Loss Harvesting work.
- Short-Term Capital Gains: If you hold an asset for less than a year and sell it for a profit, you are taxed at your Ordinary Income rate. This means the profit are added on top of your regular income and taxed at your marginal rate.
- The Pain: Federal rates can go as high as 37%. When you add the Net Investment Income Tax (3.8%) and high state taxes (like California’s top bracket), your short-term gains can be taxed at over 50%.
- 2025 tax bucket for ordinary income
Tax Rate For Single Filers For Married Individuals Filing Joint Returns For Heads of Households 10% $0 to $11,925 $0 to $23,850 $0 to $17,000 12% $11,925 to $48,475 $23,850 to $96,950 $17,000 to $64,850 22% $48,475 to $103,350 $96,950 to $206,700 $64,850 to $103,350 24% $103,350 to $197,300 $206,700 to $394,600 $103,350 to $197,300 32% $197,300 to $250,525 $394,600 to $501,050 $197,300 to $250,500 35% $250,525 to $626,350 $501,050 to $751,600 $250,500 to $626,350 37% $626,350 or more $751,600 or more $626,350 or more - Long-Term Capital Gains: If you hold an asset for more than a year, you are taxed at preferential rates.
- The Benefit: These rates generally range from 0% to 20%.
- 2025 Long-term capital gain tax bucket
Capital gains tax rate Single (taxable income) Married filing separately (taxable income) Head of household (taxable income) Married filing jointly (taxable income) 0% Up to $48,350 Up to $48,350 Up to $64,750 Up to $96,700 15% Over $48,350 to $533,400 Over $48,350 to $300,000 Over $64,750 to $566,700 Over $96,700 to $600,050 20% Over $533,400 Over $300,000 Over $566,700 Over $600,050
How Does it Actually Work?
Here is a concrete example:
Imagine you are in a high tax bracket (combined federal/state tax rate of 40%).
Let’s say you bought an S&P 500 ETF for $10,000. A few months later, its worth $9,000.
- Instead of just sitting there feeling bummed, you sell it.
Now you have a $1,000 short-term realized loss. That loss can offset gains elsewhere—or reduce your regular income by up to $3,000 per year. Any leftover losses? They roll forward to future years.
- At the same time, you used the $9,000 to buy an equivalent amount of VTI (which tracks an index that’s 99% correlated with S&P 500).
- 1 year later, you sell your portfolio. Because your cost basis is lower, you pay taxes on the gain—but you pay at the Long-Term Capital Gains rate (e.g., 20%)
Assumptions: $100,000 starting investment. Same market returns.
40% ordinary tax rate.
20% long-term capital gains rate.
Year 1
| Buy & Hold | Tax-Loss Harvesting | Note | |
|---|---|---|---|
| Starting Investment in SPY | $100,000 | $100,000 | |
| Middle of year 1: Market drops 10% | portfolio drops to $90,000 | portfolio drops to $90,000 | |
| Action | Do nothing | Sell SPY, buy $90k worth of VTI* | You've realized a $10,000 loss. This loss can offset other capital gains or up to $3,000 of ordinary income. At a 40% tax rate, that's $4,000 you don't owe the IRS. |
| At the end of year 1: Market recovers | $100,000 | $100,000 | |
| Reinvest refund | — | +$4,000 | |
| Year-end portfolio | $100,000 | $104,000 | |
| Cost basis | $100,000 | $94,000** |
* VTI tracks an index highly correlated with S&P 500—similar exposure, different fund.
**Cost basis = $90,000 (VTI purchase) + $4,000 (reinvested savings) = $94,000
Year 2: Liquidate
| Buy & Hold | Tax-Loss Harvesting | Note | |
|---|---|---|---|
| End of year 2: market does not move | $100,000 | $104,000 | |
| Action | Sell everything | Sell everything | |
| Pay Tax (25% LT rate) | $0 | −$2,000 | Capital gain = $104k - 94k = 10k). with 20% rate, you need to pay 10k* 20% = 2000 to IRS |
| Final value after-tax cash | $100,000 | $101,500 |
Summary
| Buy & Hold | Tax-Loss Harvesting | Difference | |
|---|---|---|---|
| Tax saved Year 1 | $0 | +$4,000 | |
| Tax paid Year 2 | $0 | −$2,000 | |
| Net tax benefit | $0 | +$2,000 | +$2,000 |
What happened:
- You deducted the loss at your 40% tax rate
- You paid back the gain at the 20% long-term rate
- You kept the 20% difference = $2,000
Two Ways to Supercharge Tax-Loss Harvesting
1. Do It Consistently, Not Just Once
Tax-loss harvesting isn't a one-time move. It's an ongoing habit. Markets dip all the time—sometimes the whole market, sometimes just certain sectors or holdings. Each dip is a harvesting opportunity.
2. Reinvest the Tax Savings
This is where the magic happens.
When you get that tax refund, don't spend it. Put it back into your portfolio.
The Wash Sale Rule (Don't Skip This)
There's one rule you need to know: the wash sale rule.
If you sell an investment at a loss, you can't buy back the same investment—or something "substantially identical"—within 30 days. If you do, the IRS disallows the loss.
What counts as "substantially identical"?
| Scenario | Substantially Identical? | Wash Sale? |
|---|---|---|
| Sell SPY, buy SPY | ✅ Yes (same ETF) | ❌ Violation |
| Sell Vanguard S&P 500 ETF, buy Schwab S&P 500 ETF | ✅ Yes (same index) | ⚠️ Potential Violation |
| Sell SPY (tracks S&P 500), buy VTI (tracks Total US Market) | ❎ No (different indexes) | ✅ Allowed |
Some of the solid good swaps (from scenario 3):
| Asset Class | Primary ETF | Primary Index | Alternate ETF | Alternate Index | Correlation |
|---|---|---|---|---|---|
| US Stocks | VTI | CRSP US Total Market | ITOT | S&P Total Market Index | >99% |
| Foreign Stocks | VEA | FTSE Developed All Cap ex US | SCHF | FTSE Developed ex US | >99% |
| Emerging Markets | VWO | FTSE Emerging Markets All Cap China A Inclusion | IEMG | MSCI Emerging Markets Investable Market | >99% |
| Dividend Stocks | VIG | S&P US Dividend Growers | DGRO | Morningstar US Dividend Growth | 98% |
| TIPS | SCHP | Bloomberg US Treasury Inflation-Linked Bond | VTIP | Bloomberg US 0-5 Year TIPS | 85% |
| US Bonds | BND | Bloomberg US Aggregate Float Adjusted | BIV | Bloomberg US 5-10 Year Gov't/Credit Float Adjusted | 96% |
| Corporate Bonds | LQD | Markit iBoxx USD Liquid Investment Grade | VCIT | Bloomberg US 5-10 Year Corporate | 97% |
Always consult a tax professional regarding your specific situation.
Want to see more? Wait for the tax harvesting calculator in the Fin2Cents App
The Bottom Line
When the market dips, don't panic. Look for opportunities.
Tax-loss harvesting turns temporary losses into real tax savings - without changing your investment strategy.
It's not exciting. It's not sexy. But over time, it adds up.
And in investing, boring wins.
