Tax-loss harvesting is a strategic method to reduce your tax bill by selling investments that have declined in value from their purchase price within taxable accounts such as individual or joint brokerage accounts. This technique allows you to offset realized gains—profits from selling investments at a higher price than their purchase price—elsewhere in your portfolio, potentially reducing your taxable income.
Understanding the concept of gains and losses is crucial for effective tax-loss harvesting. An unrealized gain or loss is relevant for investments you still hold. It represents the difference between the current market value of an asset and its original purchase price, or cost basis. This gain or loss only becomes realized when you sell the investment. At that point, the difference between the sale price and the cost basis becomes a factor for tax purposes.
To implement tax-loss harvesting effectively, keep these key points in mind:
The end of the fiscal year is a common time to assess your portfolio for tax-loss harvesting opportunities, but monitoring your investments regularly allows for more strategic decisions throughout the year.
The IRS prohibits claiming a tax deduction for a security sold in a wash sale. A wash sale occurs if you buy a “substantially identical” security within 30 days before or after selling a security at a loss. To avoid this, consider replacing the sold security with one that serves a similar role in your portfolio but is not considered substantially identical. You can replace it with an ETF or mutual fund that provides exposure to the same asset class, and often a similar segment of that asset class.
First, use your realized losses to offset any realized gains. If your losses exceed your gains, you can use up to $3,000 ($1,500 if married filing separately) of excess losses per year to offset other income, such as wages. Any remaining losses can be carried forward to future tax years indefinitely.
Be mindful of the distinction between long-term and short-term gains and losses. Long-term gains (on assets held for more than a year) are taxed at a lower rate than short-term gains. Prioritize harvesting losses that can offset gains of the same type to maximize tax benefits.
Tax-loss harvesting should not be the sole reason for selling an asset—always weigh it against your broader investment goals and market conditions.
Direct indexing: TLH at scale. A single broad-market ETF offers no harvest opportunities once the fund as a whole is up: the IRS sees one position, and the position is green. Direct indexing replaces that single fund with the underlying 300, 500, or 1,000 component stocks held in your own account, each with its own basis. Even in a year the index is up 20%, a meaningful subset of names is down — and each of those positions can be harvested individually without selling the winners, with the proceeds rotated into a non-substantially-identical replacement (a different sector ETF, or a different name in the same sector) for the 31-day window. At larger portfolio sizes the harvested losses run 2–5% of portfolio value per year in the early years, then decay as the embedded gain on the original lots dominates. Those losses offset $3,000 of ordinary income annually and an unlimited amount of realized capital gains — making direct indexing the natural pair for an investor with concentrated equity-comp gains, a recurring private-company exit, or a long-dated estate plan that anticipates basis step-up at death anyway. The cost of the service has compressed: most large brokerages now offer direct indexing as a managed-account product at 15–40 bps on top of zero-commission execution. The fee plus tracking error against the underlying index has to be weighed against the realized tax alpha; for a high-bracket investor with substantial taxable gains, the trade is almost always positive in the first decade of the account and turns marginal once the harvest yield decays.