How It Works
When you own investments in a taxable brokerage account, the IRS taxes you on capital gains (profits). If you sell an investment for more than you paid, that's a taxable gain.
The strategy: Sell a *different* investment that's currently in a loss. That loss offsets (reduces) your taxable gains.
Example: You bought 100 shares of Fund A at $100/share ($10,000 total). It's now worth $8,000. You also own Fund B (purchased at $5,000, now worth $7,000 — a $2,000 gain). Sell Fund A at a $2,000 loss. That loss cancels out the $2,000 gain from Fund B. Your net capital gain for the year: $0. You owe $0 in capital gains taxes.
The Wash-Sale Rule
This is the catch: You can't immediately buy back the same or "substantially identical" investment. The IRS calls this the wash-sale rule.
The rule: If you sell a security at a loss and buy a substantially identical one within 30 days *before or after* the sale, the loss is disallowed. This creates a 61-day total "window" where the rule applies.
What counts as "substantially identical"?
- The same stock (yes, the exact same company shares)
- The exact same mutual fund or ETF
- A call option on the same stock
What does NOT trigger the wash-sale rule:
- Buying a *different* index fund. If you sell the S&P 500 fund at a loss, you can immediately buy a Total Stock Market fund.
- Buying a similar but not identical fund in the same category.
- Your spouse buying the same security (wash-sale rules apply across both spouses' accounts).
Real Example: Avoiding the Wash Sale
Scenario: You own Vanguard S&P 500 ETF (VOO) worth less than you paid. You want to harvest the loss but stay invested in the U.S. stock market.
Solution: Sell VOO at a loss. Immediately buy a different broad index fund like Fidelity's FSKAX (Total Market Index). Wait 31 days. Then sell FSKAX and buy VOO back.
Result: You harvested the loss, maintained stock market exposure, and avoided the wash-sale rule because VOO and FSKAX are not substantially identical.
When Tax-Loss Harvesting Saves Money
You have capital gains to offset. The benefit only exists if you sold winners earlier in the year and owe taxes on those gains. Without gains, the loss just carries forward to next year (no benefit today).
Your taxable gains are large. If you're sitting on $10,000+ in unrealized gains across all positions, harvesting losses is worth the effort.
Your marginal tax rate is high. If you're in the 22% or higher tax bracket, harvesting a $5,000 loss saves you $1,100 or more in taxes. For lower earners, the benefit shrinks.
When It's Not Worth Doing
You have no capital gains. If you only hold winners (or losses), there's nothing to offset. Your loss carries forward to the next year.
Your taxable gains are small. If your total gains are under $2,000, the tax benefit is small relative to the hassle of tracking wash sales and switching funds.
You're in a low tax bracket. Filers with income under $47,150 (22% bracket and below) see less benefit from harvesting. Your capital gains might qualify for the 0% long-term capital gains rate anyway.
Important Notes for ITIN Holders
Tax-loss harvesting only applies in taxable brokerage accounts. You cannot harvest losses in a Roth IRA, Traditional IRA, or 401(k). Losses in those accounts don't trigger taxes, so harvesting doesn't help.
ITIN holders file taxes like SSN holders. The wash-sale rule and capital gains taxation apply the same way. The only difference is that you use your ITIN number instead of an SSN when filing.
Keep records. Track all buy and sell dates, prices, and fund names. Your brokerage sends tax forms (Form 1099), but having your own records helps if the IRS questions a wash sale.
Frequently Asked Questions
What is tax-loss harvesting?
Selling an investment that is down to realize a capital loss, which offsets capital gains and up to $3,000 of ordinary income per year, lowering your tax bill. You reinvest in a similar — but not "substantially identical" — asset to stay in the market.
What is the wash-sale rule?
If you sell at a loss and buy the same or a substantially identical security within 30 days before or after, the IRS disallows the loss. Avoid it by waiting 31 days or buying a different fund that tracks a similar (not identical) index.
Does tax-loss harvesting help ITIN holders?
It helps anyone with a taxable brokerage account who files a U.S. tax return, including ITIN holders. It does nothing inside a Roth IRA or 401(k), since those accounts are not taxed on gains.
When is it not worth doing?
When the losses are tiny, when you have no gains and little taxable income to offset, or when selling would cost more in fees and complexity than the tax it saves. It is a bonus, not a reason to invest.