What it means
Capital gains tax is generally charged on gains you have actually realised by selling, not on gains that exist only on paper. That creates a timing choice: if you are sitting on both winners and losers, selling some losers in the same tax year offsets the gains you have crowned.
The tax saved is the loss multiplied by your capital gains rate. The technique is most valuable in a year with large realised gains, such as when a business stake is sold or a portfolio is rebalanced.
It is also useful in volatile markets where individual holdings fall even as the overall portfolio rises. Losses that exceed gains can usually be carried forward indefinitely, so harvesting in a bad year builds a reserve against future gains.
The main constraint is the rule preventing you from selling and immediately repurchasing the same asset, often called a wash sale or bed-and-breakfast rule. Buy back the identical security within the specified window, typically 30 days either side, and the loss is disallowed.
The workaround is to reinvest in a similar but not identical holding, such as a different index fund tracking the same market. Harvesting is a deferral more than an outright saving in many cases.
Reinvesting at a lower price reduces your cost basis, so a larger gain arises when you eventually sell, which is why the real benefit is the time value of paying tax later plus any difference in rates between now and then. If your rate is expected to rise, harvesting can even backfire.
Practical execution matters more than the concept. Transaction costs, bid-offer spreads, the risk of being out of the market during a switch, and the administrative burden of tracking basis all reduce the benefit on small positions.
Most advisers set a minimum loss threshold before bothering.
In practice
Real-world examples.
Example
A founder sells part of his company stake and realises a $2,000,000 gain. His adviser harvests $350,000 of losses from a diversified portfolio in the same year, cutting the taxable gain to $1,650,000 and saving $70,000 at a 20% rate.
Example
A retail investor sells an exchange traded fund at a $12,000 loss and repurchases the identical fund nine days later. The loss is disallowed under the wash sale rule and simply added to the cost of the new holding, delivering no current-year benefit.
Example
A family office runs an automated review every December, harvesting any position with a loss above $25,000 and reinvesting in a substitute fund tracking the same market. Over five years it accumulates $900,000 of carried-forward losses that offset the gain on a later property sale.
Think of it
“Tax loss harvesting is selling losers to save taxes-realizing losses strategically.
Formula
Calculation
Formula: Tax saved = Harvested loss x Capital gains tax rate, subject to the loss being usable against gains in the same year or carried forward.
Worked example: an investor realises $150,000 of capital gains during the year from selling appreciated shares, taxed at 20%, which would produce tax of $150,000 x 20% = $30,000. She also holds a fund position showing an unrealised loss of $40,000 and sells it before year end, immediately reinvesting in a different fund tracking a similar index.
Net taxable gains become $150,000 - $40,000 = $110,000, giving tax of $110,000 x 20% = $22,000. The harvesting saved $30,000 - $22,000 = $8,000, which is exactly $40,000 x 20%. Her cost basis in the new fund is $40,000 lower than before, so the saving is a deferral rather than a permanent gift.Case study
Seen in the real world.
Pellworth Family Investments is a fictional family investment vehicle used here as an illustrative example. In a year when it sold a long-held commercial property for a $1,200,000 gain, the trustees expected a tax bill of $240,000 at 20% and had budgeted the cash accordingly.
Reviewing the securities portfolio, the adviser identified three holdings sitting on combined unrealised losses of $310,000, none of which the trustees particularly wanted to keep. Selling them before year end and reinvesting the proceeds in broader index funds reduced the net gain to $890,000 and the tax to $178,000, freeing $62,000 of cash. Because the replacements were genuinely different funds, no wash sale issue arose.
The trustees noted in the fictional minutes that the exercise had not made them richer in market terms, since the portfolio value was unchanged the day after. What it did was move $62,000 of tax into the future while tidying holdings they had been meaning to exit for two years.
Watch out
Common mistakes.
- Repurchasing the identical security within the wash sale window, which disallows the loss and turns a planned saving into an administrative headache.
- Harvesting losses in a year with no gains and no expectation of future gains, so the loss sits unused while the transaction costs are real.
- Letting the tax tail wag the investment dog by selling a holding you wanted to keep purely to book a loss.
Questions
People also ask.
Does harvesting eliminate tax or just delay it?
Usually it delays it, because reinvesting at a lower price reduces your cost basis and increases the eventual gain.
Can losses be carried forward if they exceed my gains?
In most systems yes, indefinitely against future capital gains, though the rules on setting them against ordinary income are far more restrictive.
Is it worth doing on a small portfolio?
Often not, since spreads, dealing costs and record keeping can outweigh the saving on losses below a few thousand dollars.
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