Tax-Loss Harvesting: How to Turn Market Drops Into Tax Savings
With the S&P 500 down nearly 4% year-to-date and individual stocks scattered across a wide range of gains and losses, this is exactly the kind of market where tax-loss harvesting can save you real money. The strategy is straightforward, but the IRS rules have sharp edges that catch people off guard.
Tax-loss harvesting is the practice of selling investments that are sitting at a loss, using those realized losses to offset capital gains or reduce your taxable income, and then reinvesting the proceeds in a similar (but not identical) holding so your portfolio stays on track. It is one of the few tax strategies that works in your favor during a down market.
How Does It Actually Work?
Say you bought a technology ETF for $50,000 last year and it is now worth $42,000. You have an unrealized loss of $8,000. If you sell, that loss becomes realized, and the IRS lets you use it in two ways.
First, you can offset capital gains dollar for dollar. If you sold another investment earlier this year for a $10,000 gain, your $8,000 harvested loss reduces the taxable gain to $2,000. You pay taxes only on the net $2,000.
Second, if your losses exceed your gains, you can deduct up to $3,000 per year against ordinary income ($1,500 if married filing separately). Any unused losses beyond that carry forward indefinitely to future tax years. There is no expiration date on carried-forward capital losses.
Using the example above, if you had no capital gains at all, you could deduct $3,000 of that $8,000 loss against your salary or other ordinary income in 2026. The remaining $5,000 carries forward to 2027, where it first offsets any gains and then up to $3,000 more can offset ordinary income again.
What Are the 2026 Capital Gains Rates?
The tax savings depend on your bracket. For 2026, long-term capital gains rates (assets held longer than one year) are:
| Filing Status | 0% Rate | 15% Rate | 20% Rate |
|---|---|---|---|
| Single | Up to $49,450 | $49,451 to $545,500 | Over $545,500 |
| Married filing jointly | Up to $98,900 | $98,901 to $613,700 | Over $613,700 |
Short-term capital gains (assets held one year or less) are taxed as ordinary income, which can run as high as 37% at the federal level. Harvesting a short-term loss that offsets a short-term gain saves you more per dollar than harvesting a long-term loss.
The Wash Sale Rule: Where People Get Tripped Up
The IRS does not let you sell an investment at a loss and immediately buy it back. That is called a wash sale, and it is governed by IRC Section 1091. The rule is simple in concept but tricky in practice.
If you sell a security at a loss and purchase a “substantially identical” security within 30 days before or after the sale, the loss is disallowed. The IRS adds the disallowed loss to the cost basis of the replacement security, so the tax benefit is deferred rather than eliminated, but you lose the ability to use it now.
The 30-day window runs in both directions, creating a 61-day total blackout period: 30 days before the sale, the sale date, and 30 days after. The rule also applies across all accounts you and your spouse control, including IRAs and 401(k) plans. If you sell a stock at a loss in your brokerage account and your spouse buys the same stock in her IRA within 30 days, the loss is disallowed.
How to Harvest Losses Without Breaking the Rules
The cleanest approach is to sell the losing position and buy something similar but not substantially identical. For example:
ETF swaps. Sell one S&P 500 index fund and buy a different provider’s total market fund. The IRS has not defined “substantially identical” precisely for index funds, but switching from a narrow index tracker to a broader one, or switching fund families, is generally considered safe by tax professionals.
Sector shifts. If you are harvesting a loss in a technology sector fund, you could reinvest in a broader growth fund that includes technology exposure alongside other sectors.
Wait 31 days. If you want to repurchase the exact same security, simply wait 31 calendar days after the sale. The loss is clean, and you can buy it right back. The risk is that the investment rises during the waiting period and you miss the recovery.
When Does Tax-Loss Harvesting Make Sense?
Not every loss is worth harvesting. Here are the situations where it adds the most value:
You have realized gains to offset. If you sold a winner earlier this year, harvesting a loser to offset that gain is the most direct tax benefit.
You are in a high tax bracket. The $3,000 ordinary income deduction is worth $1,110 to someone in the 37% bracket but only $360 to someone in the 12% bracket. The higher your rate, the more harvesting saves.
The market is volatile. Down markets and choppy markets create more harvesting opportunities. The S&P 500’s pullback in 2026, combined with sector dispersion from the Iran conflict and tariff uncertainty, means many portfolios have both winners and losers right now.
You have a long time horizon. Carrying losses forward into future years means the strategy compounds over time. A 35-year-old harvesting losses today may use those carried-forward losses to offset gains from a home sale or business exit decades from now.
When Does It Not Make Sense?
In tax-advantaged accounts. You cannot use tax-loss harvesting in a 401(k), IRA, or Roth IRA because gains and losses inside those accounts are not taxed annually.
If you are in the 0% capital gains bracket. Single filers earning under $49,450 and joint filers under $98,900 already pay 0% on long-term gains. Harvesting losses to offset gains that would have been tax-free anyway wastes the loss.
If transaction costs exceed the tax benefit. For very small positions, the cost of selling and buying a replacement may outweigh the savings. This is less of an issue today with most brokerages offering commission-free trading.
The Bottom Line
Tax-loss harvesting is not a way to avoid taxes permanently. It is a way to control when you pay them, and in many cases, to reduce the total amount you pay over your lifetime by converting short-term gains into deferred long-term positions. In a year like 2026, with markets under pressure and uncertainty running high, it is one of the most practical tools available to investors in taxable accounts.
The key is to act throughout the year when opportunities appear, not just in December. And always respect the wash sale rule. The IRS is very clear about it, and your brokerage reports wash sales directly to them.
Ferrante Capital LLC is a registered investment adviser. This content is for informational and educational purposes only and does not constitute personalized investment or tax advice. Tax-loss harvesting involves risks including the potential for wash sale violations and changes in portfolio composition. Consult a qualified tax professional before implementing any tax strategy. Forward-looking statements reflect our views as of the publication date and are subject to change. Past performance is not indicative of future results.