What Is Tax-Loss Harvesting? (And Should You Do It?)
Tax-loss harvesting lets you use investment losses to reduce your tax bill. Here is exactly how it works, when it makes sense, and the wash-sale rules you need to understand.
Tax-loss harvesting is one of those strategies that sounds complicated but has a simple core idea: when one of your investments is sitting at a loss, you sell it to realise that loss for tax purposes, and immediately reinvest in something similar to maintain your market exposure. The loss reduces your taxable gains — but you stay invested.
Done correctly, it improves your after-tax returns without changing your long-run investment strategy. Done incorrectly — or applied when the rules do not apply — it can create tax problems or transaction costs that outweigh the benefit.
How tax-loss harvesting works: a simple example
Suppose you hold two investments in a taxable brokerage account:
Investment A: bought at $10,000, currently worth $14,000 (gain of $4,000)
Investment B: bought at $8,000, currently worth $5,500 (loss of $2,500)
If you sell Investment A, you owe capital gains tax on $4,000. If you also sell Investment B to harvest the $2,500 loss, you can offset it against the gain — so you only pay capital gains tax on $1,500 instead of $4,000.
After selling Investment B, you immediately reinvest the $5,500 proceeds into a similar (but not identical) investment, so your market exposure is maintained.
The wash-sale rule (US) and equivalent rules elsewhere
The critical constraint is the wash-sale rule (US) — and similar rules in other countries — which prevents you from claiming a loss if you buy back the same or "substantially identical" security within 30 days before or after the sale.
| Country | Relevant rule | Window |
|---|---|---|
| United States | Wash-sale rule (IRS) | 30 days before or after sale |
| United Kingdom | Bed and breakfasting rule (HMRC) | 30 days — same fund repurchase |
| Canada | Superficial loss rules (CRA) | 30 days before or after sale |
| Australia | No specific wash-sale rule, but substance-over-form applies | ATO scrutinises same-day repurchases |
| Germany | No equivalent rule — but losses have annual cap | N/A |
The workaround: instead of buying back the identical ETF you sold, buy a similar but different one. For example, sell a total US stock market ETF and buy an S&P 500 ETF. They are not identical, so the wash-sale rule does not apply, but your market exposure is similar.
When tax-loss harvesting makes sense
You have realised gains to offset in the same tax year
Losses harvested without offsetting gains are carried forward. That can be useful, but the immediate tax benefit only materialises when you have gains to net against.
Your investments are in a taxable (non-sheltered) account
Tax-loss harvesting is irrelevant inside a TFSA, ISA, Roth IRA, or other tax-free account. Gains inside these accounts are already sheltered from tax.
The loss is meaningful relative to transaction costs
If you pay $10 in brokerage commissions to harvest a $50 loss at a 15% tax rate — a $7.50 saving — the transaction cost outweighs the benefit. Only meaningful losses are worth the administrative effort.
You are in a higher marginal tax bracket
The higher your capital gains tax rate, the more valuable the loss offset. In lower tax brackets, the benefit is smaller.
When it does NOT make sense
- All your investments are inside tax-sheltered accounts (ISA, TFSA, Roth IRA)
- You are in a low-income year with minimal capital gains tax liability
- The transaction costs of selling and repurchasing outweigh the tax saving
- You sell and immediately repurchase the identical security, triggering the wash-sale rule
- You are near year-end and cannot reinvest quickly due to settlement timing
Tax-loss harvesting and your net worth
It is worth noting that tax-loss harvesting does not increase the value of your portfolio — it defers or reduces taxes, which improves your after-tax net worth. If you sell an investment at a loss, your portfolio value falls by the amount of the loss. The tax saving is the benefit, not a free gain.
When tracking your net worth monthly, a harvest event will show a temporary dip in investment value followed by a similar reinvestment — the net worth impact is roughly neutral in the period it happens, with the benefit appearing as lower tax liability at year-end.
Should you do it yourself or use an automated service?
Many robo-advisors — Wealthfront (US), Betterment (US), Nutmeg (UK), and others — offer automated tax-loss harvesting as a premium feature. For high-balance taxable accounts, the tax savings can exceed the advisory fees, making this an efficient option.
For DIY investors, tax-loss harvesting is manageable if you have the discipline to track unrealised gains and losses, understand the wash-sale rules, and identify suitable replacement ETFs or funds to maintain your target asset allocation.