Tax-Loss Harvesting: Capital Loss Netting, the $3,000 Limit and the Wash-Sale Rule (IRC §1091)
In Short
Tax-Loss Harvesting is selling investments that have fallen in value to realize capital losses that offset capital gains and up to $3,000 a year of other income. It is commonly used by investors with taxable brokerage accounts, subject to the wash-sale rule in IRC §1091.
TL;DR
- Capital losses first offset capital gains; up to $3,000 of net loss ($1,500 if married filing separately) can offset other income each year [1][3].
- Unused net capital losses carry over to later years [3].
- A loss is disallowed if substantially identical stock or securities are bought within 30 days before or after the sale; the disallowed loss is added to the new shares' basis [2][3].
- Section 1091 refers to stock or securities; the IRS treats digital assets as property, and the statute does not mention them [2][4].
Quick Facts
| Legal Reference | IRC §§1091, 1211 |
|---|---|
| Complexity | Medium |
| Audit Risk | Low |
| Setup Cost | Low — trading costs and record-keeping |
| Time to Implement | Can be done at any time during the year; commonly reviewed before year-end |
| Illustrative Example | Illustrative example, not a projection. An investor has a $20,000 long-term gain from selling one fund and holds another fund with a $25,000 unrealized loss. Selling the losing fund realizes the loss, which offsets the $20,000 gain, and $3,000 of the remaining $5,000 offsets other income. The last $2,000 carries over to the next year. To avoid a wash sale, the investor waits more than 30 days to buy it back or buys something that is not substantially identical. Actual results depend on the facts and the tax rates involved. |
Key Numbers & Limits
| Item | Limit or Rule | Notes |
|---|---|---|
| Net Capital Loss Against Other Income | $3,000 per year ($1,500 if married filing separately) | IRC §1211(b) [1][3]. |
| Unused Net Capital Loss | Carried over to later years | [3] |
| Wash-Sale Window | 30 days before through 30 days after the sale (61 days) | IRC §1091(a) [2]. |
| Disallowed Wash-Sale Loss | Added to the basis of the replacement shares | IRC §1091(d) [2][3]. |
What Is Tax-Loss Harvesting?
Tax-loss harvesting is the practice of selling investments that are worth less than their basis so that the realized capital losses reduce taxable capital gains and, within limits, other income [1][3]. It does not create a new loss; it realizes a loss that already exists in the account.
Capital losses are first netted against capital gains, short-term against short-term and long-term against long-term, and then against each other. If losses exceed gains, an individual can deduct up to $3,000 of the net loss against other income each year, or $1,500 if married filing separately, and carry the rest over to later years [1][3].
The main limit is the wash-sale rule in IRC §1091. A loss on a sale of stock or securities is not allowed if the seller acquires substantially identical stock or securities, or a contract or option to acquire them, during the period from 30 days before to 30 days after the sale [2]. The disallowed loss is not lost; it is added to the basis of the new shares [2][3].
Digital assets are a separate question. The IRS treats digital assets as property, not currency [4]. Section 1091, by its terms, applies to shares of stock or securities and does not mention digital assets [2]. Whether a particular token is a security is a separate legal question, and brokers now report digital asset sales on Form 1099-DA starting with 2025 transactions [4].
How Does Tax-Loss Harvesting Work?
- The investor reviews a taxable account for positions worth less than their basis [3].
- They sell the position, realizing a short-term or long-term capital loss depending on how long it was held [3].
- To keep the loss, they avoid buying substantially identical stock or securities from 30 days before through 30 days after the sale, including through options [2].
- Some investors buy a different, not substantially identical investment to stay invested, or wait 31 days and repurchase [2][3].
- The sale is reported on Form 8949 and Schedule D, where gains and losses are netted and the $3,000 limit and carryover are applied [1][3].
The Good: What Are the Benefits of Tax-Loss Harvesting?
- Losses offset capital gains dollar for dollar, including short-term gains taxed at ordinary rates [3].
- Up to $3,000 of net loss a year can offset wages and other ordinary income [1][3].
- Unused losses carry over to later years [3].
- A wash sale defers the loss rather than destroying it, because it is added to the basis of the new shares [2].
The Bad: What Are the Drawbacks of Tax-Loss Harvesting?
- The new position starts with a lower basis, so more gain may be taxed when it is sold later; harvesting often defers tax rather than eliminating it.
- The $3,000 annual limit on ordinary income offset is a fixed amount in the statute that is not adjusted for inflation, so large losses may take years to use [1].
- Trading costs, bid-ask spreads and time out of the market add risk.
- Losses inside IRAs and 401(k) plans cannot be harvested, because those accounts are not taxed on each sale.
- Tracking wash sales across several accounts is the investor's job, not only the broker's.
The Ugly: What Are the Serious Risks of Tax-Loss Harvesting?
- Wash sales triggered in other accounts, such as a spouse's account or automatic dividend reinvestment, can disallow losses the investor thought were allowed [2][3].
- Claiming losses that were disallowed as wash sales can bring additional tax, interest and a 20% accuracy-related penalty on the underpayment [5].
- Selling investments mainly for tax reasons can lock in real economic losses if the investor stays out of the market and prices recover.
Who Uses Tax-Loss Harvesting?
Who It's Commonly Used By
Who It's Generally Not Suited For
- Investors whose holdings are all in IRAs, 401(k)s or other tax-advantaged accounts.
- Investors with automatic reinvestment they cannot easily pause [2].
- People in a 0% long-term capital gains bracket, where gains may not be taxed anyway.
What Are the Key Rules & Requirements for Tax-Loss Harvesting?
- Capital losses offset capital gains; up to $3,000 of net capital loss ($1,500 married filing separately) offsets other income each year [1].
- Net capital losses above the limit carry over to later years [3].
- A loss is disallowed if substantially identical stock or securities are acquired within 30 days before or after the sale [2].
- The disallowed loss is added to the basis of the replacement stock or securities [2].
- Sales are reported on Form 8949 and Schedule D [3][4].
- Digital assets are treated as property for federal tax purposes [4].
What Are Common Mistakes & Red Flags With Tax-Loss Harvesting?
- Buying back the same fund or stock within 30 days of the loss sale [2].
- Buying the same security in a spouse's account or an IRA right after the sale.
- Dividend reinvestment buying the same shares inside the wash-sale window [2].
- Swapping between funds that track the same index from different share classes without considering whether they are substantially identical.
- Selling for tax reasons alone without regard to the investment plan.
Frequently Asked Questions
How Much Capital Loss Can I Deduct Each Year?
Losses first offset capital gains. If losses are larger, up to $3,000 of net capital loss a year, or $1,500 if married filing separately, can offset other income, and the rest carries over [1][3].
What Is the Wash-Sale Rule?
Under IRC §1091, a loss on a sale of stock or securities is disallowed if substantially identical stock or securities are acquired during the period from 30 days before to 30 days after the sale. The disallowed loss is added to the basis of the new shares [2].
Does the Wash-Sale Rule Apply to Crypto?
Section 1091 applies by its terms to shares of stock or securities and does not mention digital assets [2]. The IRS treats digital assets as property [4]. Whether a particular token is a security is a separate legal question, and the treatment can change if Congress amends the law.
Do Capital Losses Expire?
For individuals, a net capital loss that cannot be used in the current year carries over to later years [3].
Sources
- 26 U.S. Code §1211 — Limitation on Capital Losses — Legal Information Institute, Cornell Law School
- 26 U.S. Code §1091 — Loss From Wash Sales of Stock or Securities — Legal Information Institute, Cornell Law School
- Publication 550 (2025), Investment Income and Expenses — Internal Revenue Service
- Digital Assets — Internal Revenue Service
- 26 U.S. Code §6662 — Imposition of Accuracy-Related Penalty on Underpayments — Legal Information Institute, Cornell Law School
Primary sources only: the Internal Revenue Code, Treasury regulations and official agency guidance. Read how Zentavos researches these reports.