Every December, brokerage account holders get some version of the same email: consider harvesting your losses before year end. The strategy behind it is simple enough to explain in a sentence. Selling an investment that has dropped in value turns a paper loss into a realized one, and a realized loss can cancel out taxes you would otherwise owe on gains.
The complications start immediately after that sentence. There is a rule that quietly disallows the loss if you buy the investment back too quickly, another rule that makes the disallowance permanent in one specific situation, and a set of brackets that determine whether the exercise saves you thirty seven cents on the dollar or nothing at all.
What a realized loss actually does
A loss only exists for tax purposes when you sell. Until then, your account statement can be down 40% and the IRS neither knows nor cares.
Once you sell, the loss goes into a netting process that the IRS lays out in Topic 409 on capital gains and losses. Short-term losses, from assets held a year or less, first offset short-term gains. Long-term losses offset long-term gains. Whatever is left over crosses sides, so an unused long-term loss can wipe out a short-term gain and the reverse.
If losses still exceed gains after all that, you can deduct up to $3,000 against ordinary income for the year, or $1,500 if you are married filing separately. Anything beyond that carries forward. There is no expiration on the carryforward, so a large loss from one bad year can shelter gains for a decade, keeping its short-term or long-term character as it goes.
Why the character of the gain matters more than the size
The value of a harvested loss depends entirely on what it offsets.
Short-term gains are taxed as ordinary income, which in 2026 means rates running up to 37%. Long-term gains, on assets held more than a year, use a separate and much friendlier schedule. For 2026 the 0% long-term rate applies to taxable income up to $49,450 for single filers, $66,200 for heads of household and $98,900 for married couples filing jointly. The 15% rate runs from there to $545,500 for single filers and $613,700 for joint filers, and 20% applies above that. Households with modified adjusted gross income over $200,000 single or $250,000 joint may also owe the 3.8% net investment income tax on top.
Those thresholds explain why harvesting is not universally worth doing. A loss used against a short-term gain for a high earner is worth roughly 37 cents per dollar, plus the surtax. The same loss used against a long-term gain by someone sitting in the 0% bracket is worth nothing at all, and it carries a cost that shows up later.
The wash sale rule
Congress noticed long ago that investors could sell at a loss on Monday, buy back on Tuesday, and claim a deduction while owning exactly what they started with. Section 1091 of the tax code closes that door.
A wash sale happens when you sell stock or securities at a loss and, within 30 days before or 30 days after the sale, you acquire substantially identical stock or securities. The window runs in both directions, which makes it 61 days total counting the day of the sale. Buying shares three weeks before you sell the rest of your position at a loss is just as disqualifying as buying them back the week after.
When a wash sale occurs, the loss is disallowed for the current year. It is not usually destroyed. As IRS Publication 550 explains, the disallowed amount gets added to the cost basis of the replacement shares, and the holding period of the original shares carries over to the new ones. The deduction is postponed until you eventually sell the replacement position. That is why a normal wash sale is better described as a timing problem than as lost money.
The rule applies to you, not to an account. Fidelity’s explanation of wash sale mechanics notes that purchases in a different brokerage account, in a spouse’s account, or through automatic dividend reinvestment can all trigger it. A monthly 401(k) contribution buying the same fund you just sold at a loss in a taxable account is the version that catches people who thought they were being careful.
The one place the loss disappears for good
There is a scenario where a wash sale stops being a deferral. Revenue Ruling 2008-5, issued in late 2007, addressed what happens when the replacement shares are purchased inside an IRA.
The loss in the taxable account is disallowed, as usual. But an IRA does not track taxable basis the way a brokerage account does, so there is nowhere for the disallowed loss to attach. Michael Kitces walked through the mechanics of the ruling when it was released, and the conclusion has not changed since: the loss is gone permanently, with no future deduction to recover it. The same logic applies to a Roth IRA.
This is why advisers pay attention to what is happening inside retirement accounts during a harvesting exercise. It is also why an automatic IRA contribution scheduled for early January deserves a look if you sold something at a loss in late December.
What your broker does and does not track
Brokerages report wash sales on Form 1099-B, and that reporting is genuinely useful, but it is narrower than most investors assume. A broker sees only its own accounts, and it generally matches only positions carrying the same identifier, meaning the identical security in the identical account.
Two accounts at two firms, a spouse’s account, an IRA held elsewhere, or a similar but not identical fund are all invisible to that process. The taxpayer carries the responsibility for identifying wash sales across every account, and the rule applies regardless of what the 1099-B reports.
What counts as substantially identical
The tax code never defines the phrase, and the IRS has never issued comprehensive guidance on how it applies to funds. Publication 550 offers the general principle that stock of one corporation is ordinarily not substantially identical to stock of another corporation.
Common practice has settled into rough conventions. Selling shares of one company and buying a competitor is clearly fine. Selling a fund and buying a different fund that tracks a different index is widely treated as acceptable. Selling an S&P 500 index fund at one company and immediately buying an S&P 500 index fund at another sits in a gray area that many tax professionals avoid, since the two hold effectively the same basket. Waiting out the 31 days, or moving to a broader total market fund, removes the question.
Where cryptocurrency stands
The wash sale rule applies to stock or securities. The IRS treats digital assets as property rather than securities, which leaves crypto outside Section 1091 as it is currently written. An investor can sell bitcoin at a loss and repurchase it the same afternoon while still claiming the loss.
Bills to extend the rule to digital assets have been introduced in multiple sessions of Congress, and none has become law as of this writing. Anyone relying on the current treatment should confirm its status before acting, since a change could arrive with an effective date that reaches back to the day a bill was introduced.
Timing, and the part that is easy to forget
For stocks and funds, the sale counts in the year of the trade date, so a harvest has to be executed by the last trading day of December to affect that year’s return.
The larger thing to keep in view is that harvesting lowers your basis. If you sell a fund at a loss and buy a replacement, the new position starts from a lower cost, which means a bigger gain when you eventually sell it. The benefit is the difference between the rate you avoid now and the rate you pay later, plus the use of the money in between. For someone who expects to be in a lower bracket in retirement, or who plans to donate appreciated shares or leave them to heirs, that difference can be substantial. For someone who expects higher rates later, harvesting can move the tax bill into a worse year.
The strategy earns its reputation when it runs against real gains, in the right bracket, with the 61 day window respected across every account in the household. Run carelessly, it produces a disallowed loss, a lower basis, and extra paperwork.