Tax-loss harvesting is a strategy that involves converting investment losses into a tax deduction while remaining invested. The benefit is dependent upon an individual’s tax situation but is generally used to limit short-term capital gains (securities held for less than 12 months). To do this, you look to sell investments in your taxable (non-retirement) account(s) that have depreciated to offset gains for investments sold for a profit. You then purchase new investments with the intent of preserving your portfolio’s overall balance and expected risk and return levels.

There are strict guidelines that must be followed, namely the IRS wash-sale rule. This prohibits repurchasing the same or a substantially identical security within 30 days before or after the sale. The term “substantially identical” does not prohibit investors from purchasing investments in the same industry, just not the same company, and can include ETFs and mutual funds. If you purchased a security several times over some timeframe, then calculating your cost basis (the price initially paid) is a little more complicated.

This strategy is generally utilized at year-end when assessing the portfolio’s performance and its impact on your taxes, but generally favors those in higher tax brackets. If your capital losses exceed your gains or even if you do not have any gains, you can use these to offset up to $3,000 in non-investment income, and any loss above this can be carried forward to future tax years.