Tax Loss Harvesting Explained With Real Examples

Nobody likes losing money in the market but what if you could turn those losses into tax savings? That’s exactly what tax loss harvesting does.

If you’ve ever sold a stock or fund at a gain and dreaded the tax bill, this strategy helps soften the blow. And if used wisely, it can add up to thousands in long-term savings.

Let’s break it down clearly, using real examples and practical advice so you can start applying tax loss harvesting in your own portfolio without running afoul of IRS rules.

What Is Tax Loss Harvesting?

Tax loss harvesting is the process of selling investments at a loss to offset gains you’ve made elsewhere in your portfolio. You can use the losses to:

Offset capital gains taxes
Deduct up to $3,000 of ordinary income per year
Carry forward unused losses to future years

The idea is simple: if one investment is down, you sell it, claim the loss, and either buy something similar or wait to repurchase it later so your overall portfolio stays on track.

A Simple Example of How It Works

Let’s say you invested in two stocks:

Stock A: Bought at $5,000, now worth $8,000 → $3,000 gain
Stock B: Bought at $6,000, now worth $3,000 → $3,000 loss

If you sold both this year:

Your $3,000 gain from Stock A would usually be taxed
But your $3,000 loss from Stock B cancels it out
Net capital gain: $0
Capital gains tax: $0

If your loss exceeded your gains, you could deduct up to $3,000 from your income and carry over the rest.

The IRS Wash-Sale Rule: What Not to Do

The IRS has a rule called the wash-sale rule, and it’s a biggie.

If you sell a security at a loss, you can’t buy the same or a “substantially identical” one within 30 days before or after the sale. If you do, the IRS disallows the loss.

Example:

You sell your ETF “ABC S&P 500 Fund” for a loss on July 1.

If you buy the same fund back before July 31 → No tax deduction allowed
If you buy a similar but not identical fund, like a total market ETF, you’re fine

Pro tip: Use an ETF from a different provider with similar exposure to avoid triggering this rule.

What Investments Are Good Candidates?

Tax loss harvesting works best with taxable brokerage accounts (not IRAs or 401(k)s) and when:

You’ve had strong gains elsewhere in the year
You hold index funds, ETFs, or individual stocks
Markets are volatile, creating short-term dips

This strategy is often automated by robo-advisors like Betterment or Wealthfront, but DIY investors can do it manually too.

Real-Life Scenarios

Scenario 1: Offsetting Capital Gains

You sold a real estate ETF for a $5,000 gain
You sell a tech stock that dropped $4,000 in value
You pay capital gains taxes only on $1,000

Scenario 2: Reducing Taxable Income

You had no gains this year
You sell losing investments worth $6,000 in losses
$3,000 reduces your ordinary income this year
The other $3,000 carries forward to next year

How to Harvest Losses Without Derailing Your Plan

You don’t want tax savings to mess up your investment strategy. To stay invested:

Sell the losing asset
Buy a similar, not identical fund (e.g., switch from a tech ETF to a Nasdaq-100 ETF)
After 30 days, switch back if you want

That way, your portfolio maintains market exposure, and you don’t lock in long-term underperformance.

Top Tools to Make It Easier

You don’t have to do all this by hand. Here are some tools and platforms that help:

Wealthfront & Betterment: Automatically harvest losses while keeping portfolios balanced
Morningstar Portfolio Manager: Track gains and losses with alerts
TurboTax & TaxSlayer: Helps apply harvested losses correctly at tax time
Personal Capital: Monitors investments and can alert you to tax opportunities

Best Practices for 2025

Start early in the year, not just in December
Track your cost basis and holding periods
Avoid triggering short-term capital gains (held under 1 year) when harvesting gains
Be cautious of wash-sale violations across accounts (e.g., selling in one account and rebuying in another IRA)

Summary Checklist: Tax Loss Harvesting

Identify losers in your taxable portfolio
Check for capital gains you’ve realized this year
Confirm losses are long-term or short-term, matching gains
Replace with a similar asset to maintain exposure
Avoid wash-sale rule violations
Use $3,000 loss to reduce income if you have no gains
Track carryover losses on future returns

Final Thought: Small Losses Today, Big Wins Tomorrow

Tax loss harvesting isn’t about beating the market it’s about being smart with what you can control. Over time, even modest harvested losses can compound into meaningful tax savings.

Done right, it’s a low-effort, high-impact move that makes your portfolio more tax-efficient.

Next up: Learn how to fine-tune your portfolio all year long with
Smart Rebalancing Techniques for Your Portfolio