Quick Read
Tax-loss harvesting lets investors sell a losing fund, instantly swap into a similar one, and bank realized losses to offset capital gains for years.
Losses offset capital gains dollar-for-dollar, then cut ordinary income by up to $3,000 annually, with any unused amount carrying forward indefinitely.
The wash-sale rule kills the deduction if you, a spouse, or an IRA buys a substantially identical security within 30 days of the sale.
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If you hold stocks or funds in a regular taxable brokerage account, there is a legal move sitting inside it that the IRS wrote into the code itself: tax-loss harvesting. You sell a position that is underwater, immediately buy a similar (but not identical) fund to stay invested, and keep the paper loss as a tax asset you can spend for years. Investors who applied this approach during the 2022 drawdown, when the S&P 500 fell 19.95% between January 3 and December 30 of that year, stayed invested by switching tickers, realized the paper loss, and could draw it down against gains in later years.
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How the Swap Actually Works
The mechanic works like this. A taxpayer sells Fund A at a loss. Within seconds, a purchase of Fund B follows, a fund that tracks a different index or a different slice of the market but moves almost in lockstep with Fund A. Think of a total market fund instead of an S&P 500 fund, or a large‑cap value ETF instead of a large‑cap blend ETF. The loss is now “realized” for tax purposes, even though the economic exposure barely blinked. That realized loss first offsets any capital gains taken during the year, dollar for dollar. Anything left over then reduces ordinary income by up to $3,000 per year. Whatever remains unused rolls forward indefinitely, year after year, until death.
Where the Rule Lives in the Code
The netting and carryforward rules come straight from the Internal Revenue Code. Section 1211(b) caps the annual ordinary‑income offset, while Section 1212(b) lets individuals carry unused capital losses forward indefinitely with no expiration date. The guardrail on the swap itself is Section 1091, better known as the wash‑sale rule, which disallows a loss if a “substantially identical” security is purchased within 30 days before or after the sale. IRS Publication 550 walks through both the netting order and the wash‑sale definition in plain, readable language.
