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Loss harvesting is the one tax move that comes with a product, a fee, and a marketing budget. Underneath, it is five steps that anyone with a brokerage account can follow by hand.
- You own a position that is down Bought for $50,000, worth $40,000 today. The $10,000 loss exists on paper only until you sell.
- Sell it The loss becomes real for tax purposes: a $10,000 realized capital loss.
- Buy something similar the same day A fund tracking a different index, or a different stock in the same industry. Your market exposure barely changes. It cannot be the same security or a "substantially identical" one, or the loss is disallowed.
- Use the loss at tax time It offsets capital gains first. Whatever is left offsets up to $3,000 of ordinary income, and the rest carries forward to later years, indefinitely.
- Notice the new cost basis The replacement lot starts at $40,000, not $50,000. When you eventually sell it, the taxable gain is $10,000 larger than it would have been.
What the loss is worth this year
At the top California rates, the same $10,000 loss saves a different amount depending on what it offsets.
| The loss offsets | Rate avoided | Tax saved now |
|---|---|---|
| A short-term gain elsewhere | 52.1% | $5,210 |
| A long-term gain elsewhere | 35.1% | $3,510 |
| $3,000 of salary (the annual cap), rest carried forward | 52.1% on $3,000 | $1,563 this year |
The catch: most of it is a loan
Step five is the part the ads skip. The loss did not make tax disappear. It moved a $10,000 gain from now into the future, when the replacement lot is sold. The lasting benefit is only the part that never comes back, and there are three ways for that to happen.
- Time value. Tax paid later is cheaper than tax paid now. On its own this is worth roughly 13 to 42 basis points a year in the published estimates.
- Rate arbitrage. Harvest against a 52% short-term gain today, pay 35% on a long-term gain later, and 17 cents per dollar stays with you. This is the only piece that reaches the 1 to 2% figures in the marketing, and it runs in reverse if your bracket goes up.
- Permanent forgiveness. Give the replacement lot to charity, or hold it until the basis steps up at death, and the deferred gain is never taxed at all.
An investor with a lump sum, a salary, and only long-term gains ahead gets the first of the three and little of the others.
Where harvesting happens in practice
A robo-adviser does this with pairs of ETFs, swapping one broad fund for a similar one on a different index. A direct-indexing account does it with hundreds of individual stocks, which gives it many more losses to find. Both live inside the wash-sale rule, covered in The wash-sale rule in four facts.