How To Lower Your Income Taxes With Tax-Loss Harvesting
Wouldn’t it be nice if every investment you made turned into a winner? Unfortunately, that’s not always the case. Sometimes, the market doesn’t go your way and you’re left holding investments that are worth less than what you paid.
The good news? You can use those losses to your advantage through a strategy called tax loss harvesting. It’s one of many tax-smart moves you should be aware of as an investor.
How Does It Work?
Here's the basic idea:
Sell an investment that has declined in value—this realizes a “capital loss.”
Use that loss to offset other taxable gains you've made during the year.
If your losses exceed your gains, you can use up to $3,000 per year to reduce your ordinary income.
If there’s still leftover loss, you can carry it forward to future tax years.
Want to stay invested in that market segment? You can reinvest in a similar (but not identical) investment. Or, if you'd like to buy the exact same investment again, you’ll need to wait 30 days to avoid running afoul of the IRS’s wash sale rule.
A Quick Example
Let’s say you sold some investments earlier this year for a short-term capital gain of $20,000. If you're in a combined 30% tax bracket, you'll owe $6,000 in taxes on that gain.
Now, let’s imagine you also have other investments showing an unrealized loss of $25,000. If you sell those, you can:
Use $20,000 of the loss to completely offset the capital gain, eliminating the tax owed.
Use $3,000 of the remaining loss to reduce your ordinary income.
Carry forward the final $2,000 to offset gains or income in future years.
Pretty efficient, right?
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Another Scenario
Maybe you have a $15,000 long-term capital loss, and no capital gains this year. If you sell now, you can:
Deduct $3,000 this year against your income.
Carry forward the remaining $12,000 to use in future years—either against capital gains or in $3,000-per-year chunks against ordinary income.
Important Note: Long-term losses can be carried forward indefinitely. So even if you can’t use them all right away, they’ll be there for you later.
A Few Key Rules to Know
1. No Tax Loss Harvesting in Retirement Accounts
This strategy only applies to taxable accounts. Losses inside your 401(k), IRA, Roth IRA, SEP IRA, SIMPLE IRA, or 403(b) accounts do not count.
2. Match Losses to the Right Type of Gains
You must first use long-term losses to offset long-term gains, and short-term losses to offset short-term gains. Only after those are matched can remaining losses be used to reduce ordinary income.
3. Beware of the Wash Sale Rule
If you sell an investment at a loss and buy the same or a “substantially identical” investment within 30 days before or after the sale, the IRS will disallow the loss for tax purposes. This is known as a wash sale.
Unfortunately, the IRS hasn’t clearly defined what counts as “substantially identical,” so you’ll need to use your best judgment.
Here are a few safe substitution examples:
Sell Pepsi stock, buy Coca-Cola
Sell Lowe’s, buy Home Depot
Sell an S&P 500 index fund, buy a Total Stock Market Index Fund or Russell 1000 Index Fund
For index funds, just make sure you're switching to a fund that tracks a different index.
4. The Wash Sale Rule Applies Across All Accounts
Even if you sell a losing investment in one account (say, at Schwab), then buy it back in another account (say, at Fidelity), that still triggers a wash sale. This applies across all taxable accounts—and even to your spouse’s accounts.
The IRS made this clear in Revenue Ruling 2008-5, which I’ll link in the show notes.
Also be cautious of automatic reinvestment plans or contributions that could accidentally trigger a wash sale in your retirement accounts.
5. Options Count Too
If you sell an ETF like the S&P 500 index and then buy an option on that ETF within 30 days, you’ve also violated the wash sale rule.
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What Should You Do Now?
With the market down, now is a smart time to:
Review your taxable accounts
Check for any unrealized losses
Consider harvesting those losses
Reinvest in similar, but not identical, investments
Avoid buying back the same investment within 30 days
Use this opportunity to consolidate or even upgrade to more tax-efficient investments like ETFs
Final Thoughts
Tax loss harvesting isn’t just damage control—it’s a smart strategy to reduce your tax burden and improve your portfolio over time.
While no one enjoys seeing red in their investment account, you can make the most of those losses. Use them to lower your tax bill now, offset future gains, or reduce ordinary income over the years.
If you have a question or topic that you’d like to have considered for a future episode/blog post, you can request it by going to www.retirewithryan.com and clicking on ask a question.
As always, have a great day, a better week, and I look forward to talking with you on the next blog post, podcast, YouTube video, or wherever we have the pleasure of connecting!
Written by Ryan Morrissey
Founder & CEO of Morrissey Wealth Management
Host of the Retire with Ryan Podcast