Tax Loss Harvesting Education

Tax loss harvesting (TLH) is the practice of selling investments that are currently worth less than what you paid for them in order to realize a capital loss. These realized losses can be used to offset capital gains from other investments, reducing the amount of taxes you owe.

If your capital losses exceed your capital gains in a given year, you can use up to $3,000 of the excess loss to offset ordinary income (such as wages). Any remaining losses beyond that carry forward to future tax years indefinitely.

TLH doesn't eliminate taxes — it defers them. If you reinvest the proceeds into a similar (but not "substantially identical") security, your portfolio stays invested while you capture the tax benefit now.

The IRS wash sale rule prevents you from claiming a tax loss if you buy the same or a "substantially identical" security within 30 days before or after the sale. The 30-day window applies in both directions, creating a 61-day total window (30 days before + the sale date + 30 days after).

If a wash sale is triggered, the disallowed loss isn't lost forever — it gets added to the cost basis of the replacement shares. This means you'll eventually recover the loss when you sell the replacement shares, assuming you don't trigger another wash sale at that time.

For example, if you sell 100 shares of XYZ at a $500 loss and then buy 100 shares of XYZ back within 30 days, the $500 loss is disallowed and added to the cost basis of your new shares. When you eventually sell those new shares, the higher cost basis results in a smaller gain (or larger loss), effectively recovering the original $500.

Permanent loss disallowance occurs when a wash sale is triggered by a purchase in a tax-advantaged account such as an IRA or Roth IRA. Unlike a normal wash sale, the disallowed loss is gone forever.

In a normal wash sale, the disallowed loss gets added to the replacement shares' cost basis, so you recover it later. But the IRS does not allow cost basis adjustments inside tax-advantaged accounts. Since the replacement shares are in your IRA, there's no cost basis to adjust — the tax benefit of that loss simply disappears.

This rule is established in Revenue Ruling 2008-5, which clarified that when a wash sale is triggered by an IRA purchase, the loss is permanently disallowed.