Tax-Loss Harvesting

Tax-loss harvesting involves selling investments that have declined in value to realize a capital loss that can offset capital gains from other investments. If your total capital losses exceed your gains, you can deduct up to $3,000 of net losses against ordinary income per year, with unused losses carrying forward to future tax years.

The wash-sale rule prohibits repurchasing a substantially identical security within 30 days before or after the sale. To maintain your desired market exposure, you can buy a similar but not identical investment. For example, if you sell a total stock market index fund at a loss, you could buy a large-cap index fund or an ETF tracking a different but correlated index.

Tax-loss harvesting is most effective for investors in higher tax brackets and those with significant realized capital gains. Some robo-advisors perform automated tax-loss harvesting daily, which can add an estimated 0.50% to 1.50% to after-tax returns annually. However, it is important to consider the long-term tax implications, as harvesting reduces your cost basis in replacement securities, potentially creating larger taxable gains in the future.