The Tax Loophole Smart Investors Use (That You're Probably Missing)

In this article I break down one of the most important and beneficial tax strategies that high earners use to lessen their tax burden in a given year

Tax season isn’t just about filing returns, it’s a chance to refine your investment strategy. One of the most effective tax-saving tools available to investors is tax loss harvesting.

When done correctly, this strategy can help reduce your tax bill, offset gains, and position your portfolio for long-term success. But it’s not for everyone, and there are important rules to follow to avoid costly mistakes.

What Is Tax Loss Harvesting?

Tax loss harvesting is the process of selling investments at a loss to offset taxable gains from other investments. The IRS allows investors to use these losses to reduce their capital gains tax liability, and if losses exceed gains, they can offset up to $3,000 of ordinary income ($1,500 for married individuals filing separately).

How It Works

1. Sell an underperforming investment at a loss. This “realizes” the loss for tax purposes.

2. Use the loss to offset capital gains. Short-term losses offset short-term gains, and long-term losses offset long-term gains (which are taxed at different rates).

3. If losses exceed gains, apply up to $3,000 to ordinary income. Any remaining losses can be carried forward to future years.

4. Reinvest strategically. To stay invested, you can purchase a similar (but not identical) investment, avoiding the IRS wash sale rule (more on that below).

When Should You Consider Tax Loss Harvesting?

Tax loss harvesting isn’t about timing the market—it’s about taking advantage of strategic opportunities. Consider using it when:

✔ You have significant capital gains – If you’ve sold stocks, mutual funds, or other assets at a profit this year, harvesting losses can help offset those gains.

✔ The market takes a downturn – A market dip can be an opportunity to realize losses while reinvesting in similar assets.

✔ You’re in a high tax bracket – If you have a high taxable income, reducing your capital gains tax can be a valuable tool for overall tax efficiency.

✔ You want to reposition your portfolio – Selling a losing investment allows you to reinvest in assets better aligned with your long-term goals.

Who Should (and Shouldn’t) Use This Strategy?

✅ Good for:

• Investors with taxable brokerage accounts (not IRAs or 401(k)s, where tax loss harvesting doesn’t apply).

• Those with capital gains that could be offset.

• Investors with long-term plans who can reinvest proceeds strategically.

❌ May not be ideal for:

• Investors who are in a low tax bracket and don’t have much to gain from offsetting income.

• Those who plan to immediately repurchase the same stock (risking a wash sale, which negates the loss).

• Anyone who panics at market downturns, tax loss harvesting is a strategic move, not emotional selling.

The Wash Sale Rule: What to Avoid

One of the biggest pitfalls in tax loss harvesting is the wash sale rule. This IRS rule prevents you from claiming a tax loss if you buy the same or a “substantially identical” investment within 30 days before or after selling at a loss.

To avoid triggering a wash sale: 

✔ Wait at least 30 days before repurchasing the same security. 

✔ Consider reinvesting in a similar (but not identical) asset to maintain market exposure. 

✔ Use ETFs or mutual funds as alternatives if selling individual stocks.

A Smart Move, If Done Right

Tax loss harvesting can be a powerful tool to manage your tax liability while keeping your investments aligned with your goals. But it requires careful execution and planning.

If you’re unsure whether this strategy fits your portfolio, consult a financial professional. A well-planned tax strategy can make a big difference, not just in April, but for your long-term wealth.