Tax Loss Harvesting: Rules and Strategies
- Matthew Kelley
- 4 days ago
- 5 min read

Tax-loss harvesting is a valuable strategy that helps investors turn losses into tax advantages. By selling underperforming investments, investors can offset gains and reduce their tax liabilities. This article explores the fundamentals of tax-loss harvesting, highlights the benefits of automating the process, and explains why it’s best to manage it year-round, rather than rushing at year-end when it can become complex and overwhelming.
An overview of tax-loss harvesting
Tax-loss harvesting allows investors to reduce taxable investment income by selling investments held at a loss to offset realized gains.
Capital gains can be realized in two ways: through mutual funds or ETFs that distribute gains at year-end, or by selling shares of funds or individual stocks. Investors often hesitate to sell a successful investment, even when it has grown to represent an oversized portion of their portfolio, because doing so triggers a taxable capital gain. Conversely, many delay selling losing investments for psychological reasons, as the loss feels less "real" if it’s not locked in by selling.
Tax-loss harvesting helps address both challenges. It offsets the tax impact of realizing gains and makes it easier to take losses by using them to reduce tax liabilities. This strategy not only minimizes taxes but also helps realign portfolios with long-term objectives and risk tolerance as market conditions change.
Important rules of tax-loss harvesting
Before executing trades to harvest losses, it’s important to understand key rules to ensure the strategy is effective.
1. Understand the Wash Sale Rule
Certain ETFs and mutual funds appear similar and track the same sectors or market indexes. You might consider selling one ETF or fund to realize the loss and immediately buy an identical one. It could seem easy to harvest the loss without changing your market exposure.
It's a nice idea, but it’s not allowed. The IRS prohibits claiming a loss if you purchase the same or a "substantially identical" security within 30 days before or after the sale. This is known as the wash sale rule, and violating it will disallow the tax benefit.
To avoid a wash sale:
You must wait at least 30 days before or after the sale (not including the day of the sale) to buy a substantially identical security.
Alternatively, purchase a different investment that provides similar but not identical exposure.
2. Offset Short-Term and Long-Term Gains Separately
The IRS requires investors to offset short-term and long-term gains and losses separately:
Short-term gains and losses apply to investments held for one year or less.
Long-term gains and losses apply to investments held for more than one year.
If you realize a short-term loss, you must use it to offset short-term gains. If the loss exceeds all short-term gains, the remainder can be applied to offset long-term gains, and vice versa.
3. Use Excess Losses to Offset Ordinary Income
If your realized losses exceed your capital gains, you can use the excess to offset up to $3,000 of ordinary income per year ($1,500 if married filing separately). Any remaining losses can be carried forward to offset gains or income in future tax years.
Tax-loss harvesting can be complicated
Selling losing positions can offer valuable tax benefits and encourage investors to reassess their portfolios. However, it’s not a process most people—or financial advisors—should attempt without specialized tools. Manually managing tax-loss harvesting is complex and time-consuming. Here's what it involves:
Steps for Manual Tax-Loss Harvesting
1. Identify and Classify Losses
Calculate potential losses from selling positions and categorize them as short-term or long-term, based on purchase dates.
If you’ve been reinvesting dividends in mutual funds, you’ll need to account for multiple “lots,” each with its own purchase date.
Specify which lots to sell, which may require submitting paperwork to your brokerage in advance.
2. Identify Positions to Trim
Pinpoint investments with unrealized gains that may have grown too large as a percentage of your portfolio.
Consider using harvested losses to offset capital gains distributed by mutual funds, though these distributions are typically announced in late November, making planning difficult.
3. Calculate and Execute Trades
Determine the number of shares to sell from each position.
Execute the sales simultaneously to balance gains and losses, aiming for a net effect as close to $0 as possible.
Ensure the final portfolio maintains desired allocations while maximizing tax benefits.
4. Reinvest Strategically
Reinvest proceeds in a way that avoids violating the wash sale rule while maintaining your target allocation and risk profile.
Choose replacement investments that align with your financial goals without triggering wash sale restrictions.
Important: Avoid searching for unrealized losses in retirement accounts like 401(k)s or IRAs. Tax-loss harvesting doesn’t apply to these accounts, as income and losses within them are not taxed.
Automation makes tax-loss harvesting easy
Many investors only consider tax-loss harvesting at the end of the year, when they’re already juggling tax planning, holiday preparations, and other tasks. An annual approach may miss optimal transaction timing, and manual tax-loss harvesting is labor-intensive. Especially at year-end, it’s easy to overlook details or make mistakes.
At Gold Medal Waters, we use a proprietary tax management system that automates this process throughout the year. Rather than relying on a one-time scramble in December, our system continuously monitors client portfolios—every single day—for potential opportunities. It evaluates each individual tax lot in real time to identify positions that have declined in value and can be sold to create a tax benefit.
What makes our system truly powerful is how it blends automation with personalization:
Tailored tax awareness – We input each client’s actual short- and long-term tax rates, allowing the system to calculate tradeoffs precisely.
Capital gains budgeting – We can set a custom gains limit for each client to stay within a tax-aware threshold.
Wash sale protection – Our platform identifies “substantially identical” securities and automatically avoids them, reinvesting proceeds into similar but compliant alternatives.
Tax-smart rebalancing – Even when rebalancing, the system considers the tax impact, reducing drag while maintaining your investment strategy.
This approach helps us maintain portfolio diversification, honor risk targets, and capture valuable tax savings—all without the stress or time burden of manually doing it.
Final Thoughts
Tax-loss harvesting is an important way to enhance after-tax returns and grow wealth, particularly when used as part of an overall tax planning strategy incorporating charitable giving, asset location, and retirement planning. A 2024 study by Vanguard found that the potential annual after-tax return generated by tax-loss harvesting typically ranged between 0.47% and 1.27%.
Please contact us to learn more about how we help clients minimize taxes and build long-term wealth using our comprehensive planning tools.
At Gold Medal Waters, we believe that serving our clients means going beyond traditional advice. We are a fee-only financial advisor dedicated to helping you reach your financial goals based on your unique needs and what you value most. Book a free, initial consultation to learn more!
Disclosure: Advisory Services are offered through Gold Medal Waters, a Registered Investment Advisor. This post and material presented are for informational and illustrative purposes only, and do not constitute investment advice and is not intended as an endorsement of any specific investment. As such, this material is not client-specific, we make adjustments in individual portfolios based on each client's financial plan, income needs, risk tolerance and total asset allocation. Interactive checklists are made available to you as self-help tools for your independent use and are not intended to provide investment advice. While Gold Medal Waters believes information derived from third-party sources to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability in regard to your individual circumstances. Investors should carefully consider the investment objectives, risks, charges, and expenses associated with any investment. The information discussed is not intended to render tax or legal advice. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Investing involves risk including the potential loss of principal, and unless otherwise stated, are not guaranteed. Past performance does not guarantee future results. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Consult your financial professional before making any investment decision.