When the markets are down, it’s easy to feel like your financial progress has stalled. But a downturn doesn’t have to be all bad news. In fact, it may offer a valuable opportunity to lower your tax bill and position yourself for a stronger recovery.
One way to do that? Through a strategy called tax loss harvesting.
Let’s walk through what it is, how it works, and when it might make sense as part of your broader financial and estate plan.
What Is Tax Loss Harvesting?
Tax loss harvesting is the practice of selling investments that have gone down in value in order to realize a capital loss. You can then use that loss to offset other gains—or even reduce your ordinary income.
It may sound like a setback, but it’s actually a smart way to make lemons out of lemonade.
How Does Tax Loss Harvesting Work?
Here’s a simple breakdown:
1. You sell an investment at a loss. Let’s say you bought shares for $10,000 and they’re now worth $7,000. Selling them “locks in” a $3,000 capital loss.
2. You use that loss to offset gains elsewhere. If you sold another investment this year for a $3,000 profit, the loss cancels out the gain—so you pay no capital gains tax on it.
3. No gains? No problem. If your losses are more than your gains, you can use up to $3,000 per year to offset regular income. And if you have more than $3,000 in losses? You can carry them forward to future tax years indefinitely.
Watch Out for the Wash Sale Rule
Here’s where it gets tricky: you can’t just sell a losing investment and immediately buy it back to claim the loss.
The IRS wash sale rule disallows a tax loss if you buy the same (or a “substantially identical”) security within 30 days before or after the sale.
That means:
- You can’t sell a stock on Monday and buy it back on Friday just to claim the loss.
- But you *can* buy a similar—not identical—investment, or wait 31 days to repurchase.
Planning around this rule is key to making tax loss harvesting work.
When Does Tax Loss Harvesting Make Sense?
Tax loss harvesting isn’t just about saving money in April—it’s part of a long-term strategy. It’s most beneficial when:
– You have capital gains to offset from the same year.
– You’re in a high-income year and want to reduce taxable income.
– You want to rebalance your portfolio *and* take a tax break along the way.
– You’re working with a financial or tax advisor to integrate it into broader planning.
Tax Loss Harvesting and Estate Planning
If you’re doing estate planning, tax loss harvesting can play a supporting role:
– It creates cash or flexibility in your portfolio that can be used for trust funding, Medicaid planning, or charitable gifts.
– It may help rebalance your asset mix in preparation for gifting or legacy strategies.
Once you pass away, any unrealized capital losses are wiped out, so it’s best to take them while you’re alive. On the other hand, it’s best to hold on to appreciated assets since they receive a step-up in basis, eliminating capital gains taxes for your heirs.
Bottom Line: Don’t Let Losses Go to Waste
A down market can feel discouraging—but tax loss harvesting offers a way to make the most of a tough situation. With the right guidance, you can use losses to reduce your tax bill, realign your portfolio, and strengthen your overall financial plan.
Before making any moves, talk to your financial advisor or estate planning attorney to make sure tax loss harvesting fits your goals, timeline, and investment strategy.