Market slumps sting, but they also open a door. Realizing losses in a taxable account can reduce current taxes, improve future flexibility, and keep your allocation on track.

With a few guardrails, tax-loss harvesting turns an otherwise painful year into a planning win.

The Opportunity

A capital loss is created when a security is sold for less than its cost basis. Losses realized in taxable accounts can offset realized gains from this year and prior carryforwards. If losses exceed gains, some tax systems allow a limited portion to reduce ordinary income (rules vary by jurisdiction), with any excess carried into future years.

Offset Gains

Start by pairing losses against realized capital gains. This includes gains from earlier sales that closed in the same calendar year and gains distributed by funds. Neutralizing gains first delivers the biggest dollar-for-dollar tax benefit because you erase the tax on those profits before touching ordinary income.

Reduce Ordinary Income

After fully offsetting capital gains, a limited amount of net capital losses may be allowed to reduce ordinary income, depending on local rules. This can lower the tax on wages, interest, dividends, pension income, and taxable withdrawals from retirement plans.

Carry Losses Forward

Any remaining net loss carries forward indefinitely in many tax systems. In future years, those carryforwards first offset new gains, then may reduce ordinary income again, subject to local limits. A disciplined harvesting program can build a “tax asset” that cushions future rebalancing or portfolio changes.

Short vs Long

The tax code nets short-term items (held one year or less) separately from long-term items (held more than one year) before combining the totals. Aim to match short-term losses against short-term gains when possible, because short-term gains are typically taxed at higher ordinary rates.

Avoid Wash Sales

The wash-sale rule disallows a loss if you buy the same or “substantially identical” security within 30 days before or after the sale that generated the loss. Disallowed losses aren’t gone forever—they adjust the new position’s basis—but they won’t help this year’s tax bill. Use a 31-day buffer to be safe.

Smart Swaps

Want to stay invested while harvesting? Swap into a similar, not identical, holding. Replace an S&P 500 index fund with a total U.S. market index fund. Rotate from a growth index to a blend index. For individual stocks, consider a sector ETF or a peer company of similar size. After the 30-day window, you can switch back if desired.

Fund Distributions

Funds can distribute capital gains even in down years if managers realized profits earlier. Those long-term gain distributions are taxable in the year received, whether reinvested or taken in cash. Harvesting external losses can neutralize those distributions and keep your tax line from surprising you in April.

Basis Matters

If your brokerage supports “specific share identification,” use it to target highest-basis or short-term tax lots for sale. That maximizes harvestable loss today and preserves lower-basis, longer-term shares for future gains potentially taxed at lower rates. Confirm your cost-basis method before placing trades.

Stay Aligned

Tax moves should never upend your risk profile. Harvest within the context of your target allocation, and use same-day replacement purchases to avoid unintended cash drag. If you’re systematically rebalancing, bundle harvesting with those trades to minimize transactions and slippage.

IRA Caution

Losses realized inside tax-deferred or tax-free accounts (IRAs, 401(k)s, HSAs) don’t generate deductions. Also beware of “cross-account” wash sales: a purchase in an IRA can void a loss from a matching sale in a taxable account. Keep the 30-day window clean across all accounts holding the same security.

Roger Young, a certified financial planner, writes, “Don’t let tax reduction techniques derail your overall investment strategy.”

Timing Nuance

Harvesting late in the year lets you tally realized gains and distributions before acting. Harvesting throughout the year captures volatility as it comes. Either way, prioritize meaningful losses after trading costs and spreads, and avoid over-trading. Set practical thresholds (for example, losses above a certain dollar or percentage).

Common Pitfalls

Don’t harvest solely to “book a deduction” if it moves you out of a well-chosen holding with no suitable substitute. Don’t buy back the same fund in a spouse’s account or an automatic investment plan during the wash-sale window. And don’t forget state tax rules, which can differ from federal treatment.

Near Retirement

If drawing income soon, harvest carefully to avoid depleting appreciated, low-volatility positions that support near-term withdrawals. Consider earmarking a conservative sleeve for upcoming cash needs and harvesting in growth sleeves where volatility is higher and substitutes are abundant.

Practical Workflow

Inventory gains and losses year-to-date. Identify candidates with clear substitutes. Confirm cost-basis settings and wash-sale risks (including automatic reinvestments). Execute the loss sale and the replacement the same day. Document tax lots, then revisit after 31 days if you plan to revert to the original holding.

Conclusion

Down markets are never fun, but they can be fertile ground for smart tax work. By harvesting losses, steering around wash-sale traps, and staying invested with thoughtful swaps, you can lower today’s tax drag and build flexibility for tomorrow.