Tax-Loss Harvesting

Why it works

Capital losses offset capital gains directly, dollar for dollar:

1. Short-term losses offset short-term gains first.
2. Long-term losses offset long-term gains first.
3. Net losses in one category offset net gains in the other.
4. Up to $3,000 of remaining net losses can offset ordinary income per year (MFJ or single; $1,500 for MFS).
5. Excess losses carry forward indefinitely to future tax years.

For a taxpayer in the 32% ordinary bracket and 15% long-term capital gains bracket:

• $10,000 of harvested losses offsetting long-term gains saves $1,500 in tax.
• The same $10,000 offsetting ordinary income (up to $3,000 per year plus carryforwards) saves $3,200 over time.

The basic mechanics

Suppose you own $50,000 of Vanguard Total Stock Market ETF (VTI), purchased at $55,000 in a prior year. The market has dropped; your unrealized loss is $5,000.

1. Sell VTI, realizing the $5,000 loss.
2. Immediately buy a similar but not "substantially identical" ETF — for example, Schwab U.S. Broad Market ETF (SCHB) or iShares Core S&P Total U.S. Stock Market ETF (ITOT).
3. You remain invested in essentially the same asset class. The market recovery benefits you just as if you'd held VTI.
4. You've generated $5,000 of loss to offset future gains or $3,000 of ordinary income this year.

The wash-sale rule

The IRS prevents "fake" losses through the wash-sale rule: if you sell at a loss and buy a substantially identical security within 30 days before or after the sale, the loss is disallowed and added to the basis of the new shares.

The wash-sale window:

• 31-day window starting 30 days before the sale and ending 30 days after.
• Applies across all your accounts (including IRAs and spouse's accounts) — you can't dodge it by buying in a different account.
• Automatic repurchases (reinvested dividends, payroll 401(k) contributions into similar funds) can trigger it accidentally.

Solutions:

• Use genuinely different funds. VTI and SCHB are not "substantially identical" per IRS guidance — different indexes, different providers. Two S&P 500 funds from different providers are a closer call.
• Wait 31 days between sale and repurchase.
• Move into a single broad fund temporarily and switch back after 31 days.

What makes funds "substantially identical"

The IRS has never definitively defined "substantially identical." Current practice:

• Clearly OK: Different indexes (S&P 500 vs Total Stock Market), different providers, different fund structures.
• Gray area: Same index from different providers (VOO vs IVV — both S&P 500 trackers). Most practitioners consider these non-identical given the legal structure differences; the IRS has not challenged.
• Clearly not OK: Same fund (selling VTI and buying VTI a week later).

Conservative practice: choose funds tracking different indexes when harvesting.

Carryforwards

Losses beyond the $3,000 ordinary-income limit carry forward indefinitely. A $30,000 loss harvested in 2025 with no gains to offset could cover $3,000 of ordinary income that year, then $3,000/year for each of the next 9 years — or be deployed all at once against a future large gain.

Carryforwards preserve their short-term or long-term character.

Optimal timing

Best candidates for harvesting:

• Late December — after most of the year's performance is known, before year-end.
• Market drawdowns — when losses are available across many positions.
• Tax-advantaged accounts don't matter — harvesting only applies to taxable accounts.
• Positions with large unrealized losses — the $5 stock that's now $2 is a prime candidate.

Is harvesting worth the hassle?

For taxpayers with:

• Large taxable accounts ($100k+)
• High marginal rates
• Diversified holdings where wash-sale swaps are easy

Harvesting can add 0.25–1.0% per year in after-tax return. Over decades, that compounds to meaningful wealth.

For smaller taxable accounts, the administrative burden often outweighs the benefit. Many roboadvisors and brokerages now automate tax-loss harvesting for a small fee.

How Horizons uses this

The Tax Harvesting page in Horizons identifies potential harvesting candidates across your taxable accounts. The engine models expected tax savings from harvesting scenarios and their impact on long-term after-tax wealth.