Tax Loss Harvesting: Rules & Examples

Instructor: Ian Lord

Ian is a real estate investor, MBA, former health professions educator, and Air Force veteran.

Tax-loss harvesting is an excellent method for reducing tax obligations, but this lesson explains how investors must also be aware of IRS rules and limits when considering this strategy.

Tax-Loss Harvesting

The end of the year is approaching, and Don is looking over his finances for any final steps he can take to save on his taxes. He's made a few contributions to charity and set money aside into a tax-sheltered retirement account. Let's look into how Don can go about using a strategy known as tax-loss harvesting to reduce his tax bill.

Definition Rules

Tax-loss harvesting is an investment strategy where an investor sells an investment that has gone down in value and buys into another investment. By selling the investment at a loss, Don may be able to deduct that loss from his taxable income. Because the money is still invested, just in a different investment, his overall financial position in the market hasn't changed. This is a making-lemons-out-of-lemonade kind of situation; Don can take a loss on paper which will at least have the benefit of reducing his tax bill.

Let's look at an example. Don purchased $1,000 worth of shares in the XYZ Company at $10.00 per share. Today the shares are worth $9.50. Don would like to switch his money into XYZ's industry rival DEF. After selling the $950 worth of XYZ stock, he purchases $950 worth of DEF. He has the same amount of money invested in the market but is now able to claim the loss of $50 on his tax return. Since Don is in the 25% tax bracket, this $50 deduction allows him to pay $12.50 less on his taxes.


In order to prevent abuse, the Internal Revenue Service has imposed regulations that specifically disallow buying an investment and then selling it shortly after that at a loss to save on taxes. This is known as the wash-sale rule. Specifically, if Don were to sell an investment at a loss and then purchase a substantially identical investment within 30 days he would not be able to claim a loss. Substantially identical is different from having a high correlation. It would be a problem for Don to sell one S&P 500 fund for another S&P 500 fund, but it would be alright to buy a US total stock market fund since both tend to move up and down in value at the same time.

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