Harvesting Tax Savings: Turning Investment Losses into Tax Opportunities

Myra J. Tucker, CFA^®
Vice President and Wealth Manager
Wealth Management

Historically, autumn was associated with the annual harvest and gathering of provisions before winter. Similar opportunities also exist in our investment portfolios. In taxable accounts, we can gather losses strategically to help offset capital gains, reduce current-year federal taxes, and preserve flexibility for future years. 

What is tax-loss harvesting?

At its core, tax-loss harvesting means selling an investment that has declined in value to realize the loss for federal tax purposes. That realized loss can then be used to offset taxable capital gains elsewhere in your portfolio. If losses exceed gains, a limited amount may also be used to offset ordinary income, with unused losses generally carried forward for federal tax purposes.

Where to use this strategy

The tax-loss harvesting approach can make sense within taxable investment accounts, where managing the tax impact of gains and losses can meaningfully affect after-tax returns. Tax-deferred or tax-free retirement accounts, such as IRAs or 401(k)s, do not realize the same benefits because gains and losses inside those accounts are not taxed in the same way. 

When and why losses can have value

A loss does not provide a federal tax benefit while it remains only “on paper.” The loss must generally be realized through a sale. Once realized, capital losses can offset capital gains dollar for dollar. This can be especially valuable when losses offset short-term capital gains, which are typically taxed at higher rates than long-term capital gains.

Tax-loss harvesting can also support broader portfolio decisions. For example, it may help reduce the tax impact of rebalancing, selling a concentrated stock position, or repositioning a portfolio for changing goals. The key is that the tax decision should complement your overall investment strategy.

Understanding the $3,000 rule

One common misconception is that investors can make use of only $3,000 of losses each year. The more precise rule is that capital losses first offset capital gains, and there is no limit on the dollar amount of losses that can be used for this purpose. However, if capital losses exceed capital gains, then up to $3,000 of the remaining net capital loss may be used to offset ordinary income in a year (or $1,500 if married filing separately). Unused capital losses can generally be carried forward indefinitely to future years for federal tax purposes.ⁱ

For example, if you realized $50,000 in capital gains and $60,000 in capital losses during the current tax year, the losses would fully offset the gains. This would leave a net capital loss of $10,000, and no federal capital gains tax would be due on those transactions. For federal tax purposes, up to $3,000 of that net loss may be deducted against ordinary income in the current tax year, subject to IRS rules and filing status.ⁱⁱ The remaining $7,000 could be carried forward to future years. This unused loss, which can accumulate with additional losses over time, is known as a tax-loss carryforward.

Avoiding the wash sale trap

A primary caution with tax-loss harvesting is the wash sale rule. In general, if you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale, the loss may be disallowed for current federal tax purposes.ⁱⁱⁱ The rule is intended to prevent investors from claiming a tax loss while effectively maintaining the same investment position.

Importantly, this does not necessarily mean you must remain in cash for 30 days. Depending on the circumstances, you may be able to reinvest proceeds in a different security that is not substantially identical, allowing you to maintain market exposure while preserving the tax benefit.^iv Careful monitoring is important, however, because wash sales can be triggered by purchases in another account, including IRAs, or by automatic dividend reinvestments. Maintaining a comprehensive view of your overall portfolio can help reduce the risk of inadvertently triggering a wash sale and preserve the intended tax benefits.

A timely planning opportunity

Fall can be an ideal time to review taxable portfolios, as it provides the flexibility to realize current-year losses thoughtfully, manage wash sale windows, and coordinate investment decisions with expected gains, income needs, charitable giving, or other tax considerations.

How Washington Trust Wealth Management can help

Tax-loss harvesting is not simply a tax exercise. It should be evaluated in the context of your income, portfolio allocation, investment objectives, and long-term financial plan. State tax rules may also differ from federal rules, so coordination with your tax advisor is important.

Washington Trust Wealth Management can help you review your taxable accounts, identify potential planning opportunities, and determine whether tax-loss harvesting may be appropriate for your circumstances. Like any good harvest, the value comes from gathering the opportunity at the right time and using it with care.