It’s a fact of investing that markets sometimes decline, and occasionally by a significant amount. It's also generally true that not all asset classes or investment styles perform well at the same time. For example, small-cap stocks may rise while large-cap stocks decline, or vice versa.
Long-term trends and return probabilities tend to favor investors who maintain diversified portfolios and avoid market timing. Patient investors with an appropriate level of risk and a long term perspective should generally remain unfazed by the types of market fluctuations described above.
In fact, there are times when investors with a long-term horizon actually benefit from short term volatility. We often point out that market declines can create opportunities to purchase additional shares at lower prices, which is particularly advantageous for regular savers who employ a dollar cost averaging strategy.
For investors with taxable brokerage accounts, temporary market declines may provide an additional benefit: the opportunity to engage in tax loss harvesting. When implemented thoughtfully, this strategy can help reduce an investor’s current or future tax liability.
Tax loss harvesting refers to selling an investment at a loss in order to realize that loss for tax purposes.1 Realized capital losses may be used to:
Any unused losses can be carried forward indefinitely and applied in future tax years.
For example, an investment purchased two years ago for $10,000 that is now worth $9,000 can be sold to realize a $1,000 long term capital loss. That loss may be used to offset other capital gains or reduce ordinary taxable income, subject to the limits above.
Note: Tax loss harvesting applies only to taxable accounts. Losses realized inside retirement accounts such as IRAs or 401(k)s do not provide a tax benefit.
An important caveat is the "wash sale" rule, under which the IRS disallows a tax loss if the investor purchases the same or a “substantially identical” security within 30 days before or 30 days after the sale that generated the loss (a 61 day window).2
The purpose of this rule is to ensure that a tax benefit cannot be obtained without a meaningful change to the investor’s economic position. Without this rule, an investor could sell a security to realize a tax loss and immediately repurchase the same holding, leaving the portfolio effectively unchanged.
If a wash sale occurs, the loss is not lost permanently; instead, it is added to the cost basis of the replacement security and may be realized later when that security is sold.
Clarification: The wash sale rule applies across all accounts owned by the taxpayer, including IRAs and other retirement accounts. A purchase in one account can disallow a loss realized in another.
When harvesting losses, most investors want to reinvest the proceeds promptly in order to maintain their desired market exposure. Care must be taken to do so without triggering a wash sale.
For investors who use index funds or ETFs (as we do at One Day In July), one common approach is to replace the sold investment with a fund that tracks a different, but reasonably similar, index.3 For example, a fund benchmarked to the Russell 1000 Index could be sold and replaced with a fund benchmarked to the S&P 500 Index. Both provide exposure to large cap U.S. equities, but they are not identical in composition.
After waiting more than 30 days, the investor may choose to switch back to the original holding if desired.
Note: The IRS has not provided a precise definition of what constitutes a “substantially identical” security. As a result, fund substitutions should be selected carefully, with attention to index methodology, holdings, and structure.
During periods of material market decline (e.g., the first quarter of 2020 or the first half of 2022), holdings may show unrealized losses. In those situations, a tax loss harvesting strategy may allow many portfolio investors to build a meaningful “loss bank.”
These accumulated losses can be carried forward and used in future years to:
Because proceeds are typically reinvested in similar securities, the investor generally maintains market exposure and does not forgo participation in a subsequent recovery.
In these environments, tax loss harvesting may allow many portfolio investors to build a meaningful loss bank.
Tax loss harvesting tends to be most valuable for investors who:
At One Day In July, tax loss harvesting is considered as part of a broader investment and wealth management strategy, and is implemented only when it aligns with an investor’s overall goals, tax situation, and long term plan.
A tax loss harvesting strategy is probably most useful to high-net-worth investors who are more likely to incur a large future capital gain that can be reduced through this strategy. At One Day In July, we will consider a tax loss harvesting strategy when it fits well with the investor’s overall investment and wealth management goals.
1. Charles Schwab: How to Cut Your Tax Bill with Tax-Loss Harvesting. https://www.schwab.com/learn/story/how-to-cut-your-tax-bill-with-tax-loss-harvesting
2. Charles Schwab. Understanding the Wash Sale Rule. https://www.schwab.com/learn/story/understanding-wash-sale-rule
3. Read more about ODIJ’s investment strategy here: https://www.onedayinjuly.com/mutual-funds-vs-etfs
The above article is based upon tax rules in place as of 2026. These rules may change in the future. The above should not be construed as tax advice, and investors should consult their tax professional.
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