What is tax loss harvesting?

Tax loss harvesting means deliberately realizing a loss on an investment to offset realized gains elsewhere, reducing your tax bill. Capital losses first offset capital gains of the same type, then the other type, and any remaining net loss can offset a limited amount of ordinary income each year, with the excess carrying forward indefinitely. The value is real but often overstated in marketing: for most investors it defers tax rather than eliminating it, because selling at a loss and reinvesting lowers your cost basis, which produces a larger gain later.

The wash sale rule is the constraint that governs execution. If you buy the same or a substantially identical security within thirty days before or after the sale, the loss is disallowed and added to the basis of the replacement. The rule applies across all your accounts including an IRA, and buying in an IRA permanently destroys the loss rather than deferring it. The standard workaround is buying a similar but not identical fund, for example swapping one broad market index fund for another tracking a different index, which maintains market exposure without triggering the rule. The IRS has not defined substantially identical precisely for funds, so staying with genuinely different indexes rather than two funds tracking the same one is the cautious approach.

Where this actually matters. It applies only to taxable brokerage accounts, since nothing inside an IRA or 401(k) is taxed on sale. It is most valuable for people in high brackets with substantial realized gains, and least valuable for those in the zero percent long-term capital gains bracket, where the deferral can even be counterproductive. The related opposite strategy, tax gain harvesting, involves deliberately realizing gains in low-income years to reset basis at no tax cost. And do not let the tax tail wag the investment dog: selling a holding you want to keep, or drifting from your allocation, in pursuit of a modest deduction is a common way to lose more than you save.