Tax-Loss Harvesting: How to Use Market Dips to Lower Your Taxes

Figures reflect rules in effect as of October 2026.

Tax-loss harvesting means selling an investment in a taxable account for less than you paid, so the loss can offset capital gains and up to $3,000 a year of ordinary income, with the rest carried forward.¹ You reinvest in something similar but not substantially identical, so the portfolio stays on plan.

A market decline leaves some positions worth less than you paid. In a taxable account, those losses can be put to use without changing much about how you are invested. The rules are simple to state and easy to trip over, so they are worth knowing before the next dip.

How does it work?

1. Sell a position that is below its cost. The difference is a realized capital loss.
2. Offset gains. Short-term losses offset short-term gains first, long-term losses offset long-term gains, and any excess offsets the other type.²
3. Offset ordinary income. If losses exceed gains, up to $3,000 a year ($1,500 if married filing separately) reduces other income such as wages. The rest carries forward to later years until it is used up.¹˒²
4. Reinvest. Buy a holding that keeps your allocation on target but is not substantially identical to the one you sold.³

For 2026, long-term gains are taxed at 0%, 15% or 20%. The 15% rate applies above $98,900 of taxable income on a joint return ($49,450 single), and 20% above $613,700 ($545,500 single).⁴ Short-term gains, on assets held a year or less, are taxed at ordinary income rates.¹

Does harvesting save tax or defer it?

Mostly, it defers. The replacement is bought at today’s lower price, so its cost basis is lower, and when you sell it the gain is larger by about the loss you took. The value comes from timing and rates: a loss used against ordinary income, or against short-term gains, can save tax at a higher rate than the later long-term gain is taxed at.

What does the wash-sale rule require?

A loss is disallowed if, within 30 days before or after the sale, you buy substantially identical stock or securities, acquire a contract or option to buy them, or buy them in your IRA or Roth IRA. A purchase by your spouse, or by a corporation you control, also counts.²

A disallowed loss is usually postponed, not lost. It is added to the cost of the new shares, and their holding period includes the old shares’. The exception is a repurchase in an IRA or Roth IRA, where that adjustment does not apply.² Common ways to trip the rule:

• a dividend reinvested in the same fund within the 30-day window;
• a purchase of the same fund in your IRA or Roth IRA;
• a purchase in your spouse’s account; and
• buying call options on the same stock.

Whether two holdings are substantially identical depends on the facts. Shares of different companies ordinarily are not.² For funds, the more defensible replacement tracks a different index; the judgment is worth making with your tax adviser.

A hypothetical example

A hypothetical investor buys $25,000 of a broad U.S. stock index fund in a taxable account. Within a year it falls to $15,000. The same year, the investor has $4,000 of short-term gains from other sales.

• The investor sells the fund for $15,000, a $10,000 short-term loss, and buys $15,000 of a fund that tracks a different broad U.S. index.
• That year, the loss offsets the $4,000 of gains, then $3,000 of ordinary income. The remaining $3,000 carries forward.
• The next year, the $3,000 carryover offsets gains or up to $3,000 of ordinary income.
• The replacement’s basis is $15,000. If it is later sold for $25,000, the gain is $10,000: the deferral described above.

When should you harvest?

Losses can appear in any month, not only in December, so reviewing on a schedule or after large market moves catches more of them than a single year-end pass. Pairing harvesting with rebalancing lets one set of trades do both jobs. Year-end harvesting fits into the year-end tax and giving review.

Owning the individual stocks of an index, called direct indexing, creates more chances to harvest, because some stocks fall even in a year the index rises. I discuss it in my post on what to do after maxing out a 401(k). Harvesting is part of the investment management I provide.

What about crypto?

The wash-sale rule applies to stock and securities.⁵ The IRS treats digital assets as property,⁶ so as of October 2026 the rule generally does not reach a crypto sale that is bought back.

That may change. On September 16, 2026, the House Ways and Means Committee approved H.R. 10357, the Digital Asset Tax Certainty Act, which would extend the wash-sale rule to traded digital assets and, as written, could reach sales made earlier this year.⁷ It is not law. Until the outcome is known, I would not plan around the gap.

Where does harvesting fit, and where doesn’t it?

• Taxable accounts only. Losses inside an IRA or 401(k) do not count.³
• Low-bracket years. Losses offset gains first, even gains that would be taxed at 0%. In a year your gains fall in the 0% bracket, a harvested loss may do little.¹˒⁴
• Investment first. Sell a holding only if the replacement serves the plan as well. A tax deduction is a poor reason to own the wrong thing.
• Charitable gifts. Give appreciated shares held more than a year rather than selling them, and harvest the losers. If you itemize, a gift of such shares is generally deductible at market value, within the AGI limits.⁸ From 2026, itemized charitable gifts count only above 0.5% of AGI.⁹ My post on reducing a concentrated stock position covers gifts of appreciated stock in more detail.
• Records. Use specific-share identification, and keep trade confirmations and a running total of carryforwards.²

These are a starting point, not a test that settles whether a given trade makes sense. That depends on your gains, your bracket this year and next, and the rest of the portfolio.

How does California treat losses?

California taxes capital gains as ordinary income, with no lower rate for long-term gains,¹⁰ at rates up to 13.3% including the 1% tax on taxable income over $1 million.¹¹˒¹² A harvested loss can therefore be worth more on the state return than the federal long-term rate suggests.

For a California resident, capital losses work much as they do federally: the same $3,000 limit against other income, and a carryover to later years. The California carryover can differ from the federal one where your California basis differs, or where part of a loss arose in a year you lived in another state.¹³

The Bottom Line

Tax-loss harvesting turns a decline into a realized loss that can offset gains and some ordinary income, while you stay invested. It mostly defers tax, so its value lies in rates and timing. The wash-sale rule is the main trap, and it reaches your spouse and your IRA. Crypto sits outside the rule for now, but a bill now in Congress would close that gap.

If you would like to see how harvesting could fit your own portfolio and tax picture, book a complimentary 15-minute call.