What is tax-loss harvesting?

Tax-loss harvesting is selling a losing investment on purpose, to lock in a loss you can use on your taxes, while immediately buying something similar so your portfolio barely changes. Sell an S&P 500 fund that is down $2,000, buy a different broad US fund the same day, and you now have a $2,000 loss to deduct and essentially the same exposure.

The loss offsets gains you realised elsewhere, and up to $3,000 of ordinary income, with the rest carried forward. At a 15 or 22 percent rate, harvesting $2,000 of losses saves a few hundred dollars this year. Robo-advisors automate this and market it heavily; you can also just do it by hand in a bad year.

It is important to understand what it does not do. The replacement fund now has a lower cost basis, so when you eventually sell it, the gain is larger by exactly the amount you harvested. You have deferred the tax, not escaped it. Deferral is still worth something, because the money compounds in the meantime and you might be in a lower bracket later, but it is smaller than the marketing suggests.

Two rules to respect: the wash sale rule, so the replacement must not be "substantially identical," and the fact that none of this applies inside retirement accounts, where losses are not deductible.