It’s Time for Tax-Loss Selling

Just a year ago, tax-loss selling (sometimes called tax-loss harvesting) was unlikely to be a profitable strategy for most investors—a niche tactic at best. Unlucky investors in individual stocks may have been able to pluck a loser or two, but the utility for mainstream investors was pretty limited. (With the benefit of hindsight, tax-loss selling was a wonderful opportunity in the baby bear market of March 2020, but my guess is that few investors took advantage of it.)

Fast forward a year, however, and losing positions have gotten more plentiful in many portfolios, especially if the holdings were purchased within the past year. The Morningstar US Market Index has shed about 13% of its value since the beginning of 2025. Growth-oriented stocks and funds, market darlings for most of the past decade, have swooned even more dramatically.

Assuming a portfolio’s asset allocation was reasonable coming into such a downturn, the best strategy in challenging conditions like the present is usually to sit tight: Getting defensive now will do nothing more than turn paper losses into real ones. But tax-loss selling is in another category because it helps achieve multiple goals. Not only does it satisfy investors’ natural tendency to take action amid volatile times—no small thing—but those losses can be used to facilitate other worthwhile activities that will benefit the portfolio plan—rebalancing, for example. Along with the opportunity to pay less in taxes on IRA conversions, tax-loss selling is one of the few silver linings of a tough market environment.

The Why and How of Tax-Loss Selling

Tax-loss selling involves selling positions in a taxable account that are trading below your cost basis—your purchase price adjusted for any commissions you paid and reinvested dividends and capital gains distributions. (You can typically find information about your cost basis on your fund company or brokerage firm’s website.) The difference between your cost basis and your sale price, assuming the sale price is lower than the cost basis, is classified as a capital loss that can be used to offset an unlimited amount of capital gains or up to $3,000 in ordinary income. Those losses don’t need to be applied in the year in which you realize them: If you take a loss this year but don’t have gains to offset, you can carry the loss forward into future tax years. Note that tax-loss selling almost exclusively applies to taxable accounts (that is, nonretirement accounts). While it’s technically possible to take a tax loss in an IRA, an investor would need to sell all of her IRA holdings to do so, and that’s rarely the right course of action

To use a simple example of how tax-loss selling would work for a taxable account, let’s say Sarah invested $100,000 in Vanguard Growth ETF VUG

at the beginning of this year. Today, her position is worth about $84,000. (The fund hasn’t performed particularly poorly in relative terms, but its whole category is down.) If she were to sell, she could realize a $16,000 loss, which she could then use to offset capital gains elsewhere in her portfolio, thereby reducing her tax bill for this year and even beyond. For example, if she wanted to reduce her position in another portfolio holding that had gained since purchase but had simply become too large a share of her portfolio, or if one of her other mutual funds made a capital gains distribution, she could use the tax loss to offset those gains. If Sarah didn’t have offsetting gains from her portfolio, she could use it to offset up to $3,000 in ordinary income, or carry the loss forward indefinitely to offset gains in future years.

Cost-Basis Method Matters

Yet tax-loss sale candidates won’t always be so obvious, especially because the current market downturn is still pretty new. For long-term investors who use broadly diversified funds and exchange-traded funds as the building blocks for their portfolios, it’s still likely that their holdings are trading above their cost basis. Selling a whole position would trigger a gain, not a loss.

Such an investor’s best shot at finding tax-loss sale candidates will be to cherry-pick specific lots of securities to sell—those with the highest cost basis that are most likely to result in a tax loss, assuming different lots of the fund were purchased at different intervals. That’s called the specific-share identification method of cost basis, and it’s especially valuable at times like this. Right now, for example, someone using the specific-share identification method might unload high-cost shares purchased in 2023 or 2024, before the market started to slide, while leaving lower-cost-basis shares in place.

The average method, whereby all of the investors’ purchase prices are averaged together, is usually the default cost-basis method for mutual funds, though it’s possible to override it by changing your cost-basis election on your provider’s website. The averaging method is simple and clean, but it obviously doesn’t allow for surgical tax-loss selling in the way that specific-share identification does. And it’s important to note that if you’ve sold shares using the averaging method in the past, you’ll have to stick with it in the future.

Meanwhile, most brokerage platforms use “first-in, first-out” as the default cost-basis election for stocks. That won’t be a fit for investors looking to unload recently purchased shares, obviously; specific-share identification would be the way to go in that situation, too.

Rebuying and Wash Sales

One tricky aspect of tax-loss selling is that the very holdings that are the most likely to yield a tax loss may also be unduly beaten down and ripe for recovery. The typical stock in Morningstar analysts’ coverage universe, for example, is currently trading at a 14% discount to its fair value, and certain sectors—technology, for example—look cheaper still.

If you wish to maintain exposure to the same market segment that you’re selling out of, you can’t simply rebuy the same security right away and still take a tax loss; you need to wait more than 30 days, or else the tax loss won’t be allowable. Nor can you rebuy what the IRS considers a “substantially identical security” within 30 days of selling a holding without disallowing the tax loss. For example, you couldn’t sell out of the ETF version of Vanguard Growth Index and buy the mutual fund version instead. But you could sell an actively managed US equity fund and buy an index fund instead; you could also replace a stock with another stock of a different company that operates within that same market sector.