Tax-Loss Harvesting Without the Wash

The deduction sitting in your red positions

Somewhere in your taxable account there is probably a lot showing red. Most attendings treat it as a mistake to be ignored until it recovers. The tax code treats it as an asset. Sell it, and the realized loss offsets your capital gains dollar for dollar with no ceiling — and then up to $3,000 of what remains offsets your ordinary income, the income taxed at your 35% or 37% marginal rate. At 35%, that single $3,000 offset is $1,050 of federal tax you do not pay, this year. Anything beyond $3,000 does not vanish. It carries forward indefinitely during your lifetime, absorbing future gains and peeling off $3,000 against ordinary income every year until it is exhausted. A large loss harvested once in a bad market can quietly reduce your taxes for a decade. The catch is a single rule from 1921: the wash sale. Rebuy the wrong thing in the wrong window — including through an autopilot purchase you forgot you scheduled — and the deduction is disallowed. In one specific case, it is destroyed permanently. This module covers the harvest, the arithmetic, and the traps, in that order.

Wash sale

A loss sale of stock or securities in which you acquire substantially identical securities, or a contract to buy them, within the 61-day window spanning 30 days before through 30 days after the sale (§1091).

The harvest itself is simple: sell a lot that trades below your cost basis, realize the loss, and immediately buy a different fund that keeps you invested in the market. You never sit in cash, so you never miss a recovery. The IRS's defense against doing this cosmetically is §1091, the wash-sale rule. If you buy "substantially identical" stock or securities — or even a contract or option to buy them — within 30 days before or 30 days after the loss sale, the loss is disallowed. Count carefully: 30 days before, the sale date, 30 days after. That is a 61-day window, and the "before" half surprises people. Shares you bought three weeks ago, including shares bought automatically through dividend reinvestment, can wash a sale you make today. "Substantially identical" is not defined by statute. The same fund at a different brokerage is identical. A different share class of the same fund is substantially identical. Two broad funds tracking different indexes have generally been treated as not substantially identical, though the IRS has never published a bright-line test — practice has varied, so keep the replacement genuinely different.

Why it matters: A washed loss is a harvest that produced nothing: you sold, you rebought, and the deduction you did it for is disallowed. In taxable accounts the loss is at least added to the new basis and deferred. When the rebuy happens inside an IRA, it is not deferred — it is gone. The entire value of harvesting depends on staying outside this window.

What a $20,000 harvest is actually worth at 35%

A 46-year-old anesthesiologist earning $450,000 (35% federal marginal bracket, 15% long-term capital gains rate) bought $120,000 of a total-market index fund that now trades at $100,000. She has no realized gains this year.

Bottom line: This $20,000 harvest is worth roughly $4,000 of rate arbitrage ($7,000 saved at 35% minus $3,000 repaid at 15%) plus years of interest-free deferral — not $20,000 of free money, and not nothing.

The wash sales you trigger without touching a keyboard

The wash-sale rule does not stop at the account you sold from — and this is where physician households with heavy automation get hurt. Your 401(k) contributes every two weeks. Your HSA sweeps into its investment menu monthly. Your spouse's accounts run their own schedules. IRS Publication 550 is explicit that a purchase by your spouse creates a wash sale just as your own purchase does, and Revenue Ruling 2008-5 extends §1091 to purchases inside your IRA — with a brutal twist. In a taxable wash sale the disallowed loss is added to the replacement shares' basis, so it is merely deferred. When the replacement purchase happens in an IRA, Rev. Rul. 2008-5 holds that the IRA's basis is not increased. The loss is not deferred; it is permanently destroyed. The IRS has not published an equivalent ruling for 401(k) plans, but the reasoning is widely read to reach them — do not test it. A $9,000 harvest can be erased because your spouse's Roth IRA bought the same fund on autopilot nine days later.

How to avoid it: Before any harvest, list every account in the household — 401(k), 403(b), 457(b), HSA, both spouses' IRAs and taxable accounts — and check what each buys automatically. Pause or redirect any automatic purchase of the fund you are selling, including dividend reinvestment, for the full 61-day window. Choose a replacement that tracks a different index than anything the household buys on autopilot. When in doubt, treat similar as too similar and pick something more distinct.

Check yourself: find the wash

The 61-day window is symmetric, and the half that reaches backward in time is the half that catches experienced investors. Work through this before your first real harvest.

On June 25 you sell shares of a large-cap index fund in your taxable account at a $6,000 loss. Which prior event partially washes the sale?

1. A $2,000 purchase of the same fund on April 30, 56 days earlier
2. A $1,500 automatic dividend reinvestment into the same fund on June 13, 12 days earlier — the answer
3. A $3,000 purchase of a bond index fund on June 20
4. Selling a different stock at a gain on June 24

The window runs 30 days before through 30 days after the loss sale. The June 13 dividend reinvestment sits 12 days before June 25, squarely inside it, so the loss is disallowed in proportion to the reinvested shares. The April 30 purchase is outside the window; a bond fund is not substantially identical to a stock fund; and realizing a gain elsewhere never triggers §1091 — gains are what harvested losses are for.

Harvest the loss, dodge the window, keep the arbitrage

• A harvested loss offsets capital gains without limit, then up to $3,000 of ordinary income per year under §1211(b) — a fixed statutory amount that has not been indexed since 1978.
• The excess carries forward indefinitely during your lifetime, but an unused carryforward cannot be inherited.
• The wash-sale window is 61 days — 30 before and 30 after — and it reaches into your 401(k), your HSA, your IRA, and your spouse's accounts.
• A replacement bought inside an IRA does not just defer the loss; under Rev. Rul. 2008-5 it destroys the deduction permanently.
• Harvesting defers tax rather than eliminating it — basis resets lower — unless the shares are held to a step-up at death or donated.

Do this next: This week, export the unrealized gain/loss view of your taxable account, flag every lot showing a loss above $1,000, and list which household accounts automatically buy those same funds — that list is your wash-sale map for the next harvest.