Finance
3 min read

Capital Loss

The loss realized when an asset is sold for less than its purchase price. Capital losses can offset capital gains for tax purposes and, in some jurisdictions, a limited amount of ordinary income.

Realizing a loss

Like capital gains, a capital loss only counts for tax purposes when realized — i.e., when you actually sell the asset. Holding a position that has fallen in value doesn't create a loss; selling it does.

If you bought 100 shares of Stock X at $50 ($5,000 cost basis) and sell at $30 ($3,000 proceeds), you've realized a $2,000 capital loss.

How losses offset gains

The US tax mechanic, in order:

  1. Short-term losses offset short-term gains first.
  2. Long-term losses offset long-term gains first.
  3. Any remaining losses can offset gains of the other type.
  4. Up to $3,000 of net capital losses per year can offset ordinary income.
  5. Excess losses carry forward indefinitely to future years.

This is why losses are economically valuable beyond their nominal dollar amount. A $10,000 loss in a year with no gains lets you deduct $3,000 from ordinary income that year and carry $7,000 forward — saving real dollars in tax depending on your marginal rate.

Tax-loss harvesting

Deliberately selling losing positions to realize losses is called tax-loss harvesting. The standard approach:

  1. Identify positions with embedded losses.
  2. Sell them to realize the loss.
  3. Use the loss to offset gains elsewhere in the portfolio.
  4. Reinvest the proceeds, often in a similar (but not "substantially identical") asset to maintain market exposure.

The "substantially identical" caveat matters because of the wash-sale rule: if you buy back the same or substantially identical security within 30 days before or after the loss sale, the IRS disallows the loss for current-year tax purposes (it gets added to the basis of the replacement, deferring rather than denying it).

For ETFs, this is usually navigated by swapping between funds that track different but correlated indexes — selling Vanguard's VTI and buying Schwab's SCHB, for instance. Both are total-stock-market funds, but they track different underlying indexes, so the wash-sale rule doesn't apply.

Crypto and the wash-sale rule

As of early 2025, the wash-sale rule does not apply to crypto in the US. The IRS treats crypto as property, and the wash-sale rule is written specifically for "securities." This means crypto holders can sell at a loss and buy back immediately, locking in the tax loss without giving up market exposure — a strategy that's not available with stocks.

Multiple Congressional proposals would extend the wash-sale rule to crypto. The strategy works under current law but isn't guaranteed to keep working long-term.

Practical ceiling

The loss-harvesting opportunity is bounded by the assets you actually have at a loss. In sustained bull markets, most positions show gains, leaving little to harvest. In bear markets or after individual position drawdowns, harvesting opportunities are abundant. Direct indexing and SMAs (separately managed accounts) offer more granular harvesting at the individual security level than off-the-shelf ETFs allow.

Don't let the tax tail wag the investment dog

A common pitfall: people sell good long-term positions purely to harvest losses, then watch them recover before the wash-sale window closes, and end up worse off than if they'd done nothing. Losses are valuable, but the underlying investment thesis still matters. Harvesting a loss in something you'd otherwise want to keep makes sense only if you can replace the exposure with something close enough that the round-trip doesn't damage your asset allocation.