What it means
In most tax systems, a profit on an investment is only taxed when you sell it, and a loss can usually be set against profits made in the same period. If you hold a share that has fallen in value, selling it creates a realised loss that reduces the tax on your gains.
The reduction is a real saving, even though the investment itself performed badly. Harvesting losses is most common near the end of the tax year, when investors review their portfolios and total up gains and losses.
Many systems also let you carry unused losses forward into later years, so a large loss is not wasted if you have no gains this year. The detail of how much can be carried forward, and for how long, varies by country.
The main constraint is the rule against buying back the same investment too quickly. In the United States this is called the wash sale rule, and it disallows the loss if you buy a substantially identical investment shortly before or after the sale.
Other countries have similar anti-avoidance rules, so investors usually switch into a similar but not identical holding to stay invested. Gain harvesting works the other way round.
An investor whose income is unusually low this year, perhaps because of a career break, may sell a winning investment while the applicable rate is low, then buy it back straight away. The new, higher purchase price reduces the gain that will arise on a later sale.
Harvesting is not free. Trading costs, bid-ask spreads and the time spent on admin all eat into the benefit, and the saving is often a deferral because the lower purchase price means more gain later.
It makes most sense for larger taxable portfolios and for people who understand the rules in their own country. The nuance is that tax should never be the only reason to sell.
A decision that sacrifices a good long-term holding to save a small amount of tax is usually a poor trade.
In practice
Real-world examples.
Example
A software engineer sold shares in her employer for a $50,000 profit in March. In December she notices that a technology fund she bought last year is worth $18,000 less than she paid. She sells the fund and switches into a similar one, so the loss reduces her gain and her market exposure stays much the same.
Example
A retired teacher has little income this year and expects higher income once a property sale completes. His adviser suggests selling shares with a $12,000 gain now, while his tax rate is low. He buys the shares back the same week, and his tax cost basis resets at the higher price.
Example
A family business holds an investment portfolio inside the company. At year end the finance manager reviews every position, identifies three that are below cost, and sells them to offset a gain from the sale of a commercial unit. The company's tax bill for the year falls by several thousand dollars.
Formula
Calculation
Tax saved = Losses used against gains x Tax rate on those gains
Suppose an investor has realised $30,000 of gains this year and holds a share with an unrealised loss of $20,000. She sells the share, so her net gain falls from $30,000 to 30,000 - 20,000 = $10,000. If the tax rate on gains is 15%, the tax falls from 30,000 x 0.15 = $4,500 to 10,000 x 0.15 = $1,500. The tax saved is 4,500 - 1,500 = $3,000.Case study
Seen in the real world.
Copperfield Capital is an illustrative, fictional investment club with 40 members and a taxable portfolio worth $900,000. Late in the year, the treasurer noticed that the club had sold two holdings for combined gains of $60,000 while several other holdings sat below their purchase prices.
The treasurer listed every position with its cost and current value. Three holdings showed unrealised losses totalling $35,000, and the club sold them and bought similar funds from a different provider so that it stayed invested.
In this illustrative story, the taxable gain for the year fell from $60,000 to $25,000, and the club saved around $5,000 of tax at an assumed rate of 15%. The treasurer also noted the dates of the sales, so the club would not repurchase the original funds inside the restricted period.
Watch out
Common mistakes.
- Selling an investment and buying the identical one straight back, which many tax systems treat as a wash sale that cancels the loss.
- Letting tax drive the whole decision, so that a strong long-term holding is sold just to save a small amount of tax.
- Forgetting that harvesting often defers tax rather than removing it, because the new lower cost basis creates a larger gain later.
Questions
People also ask.
Can losses be used against any kind of income?
Usually they offset investment gains first, and many systems let a limited amount offset other income, with the rest carried forward.
Does harvesting work inside a pension or retirement account?
No, because gains and losses inside those accounts are not taxed each year, so there is nothing to offset.
When is the best time to harvest?
Many investors review in the final months of the tax year, but it can be done at any time when a loss is available.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related