Below is a detailed, scenario-based guide to how tax-loss harvesting works, when it can be useful, and key cautions (especially wash sales and straddle rules).

How Tax-Loss Harvesting Works

• Netting and limits:

  • You first net short-term gains against short-term losses, and long-term gains against long-term losses, then net the resulting amounts to determine overall net capital gain or loss IRC § 1222; Instructions for Schedule D.

  • If the net is a capital loss, you may deduct up to $3,000 ($1,500 MFS) against ordinary income; any remaining loss carries forward indefinitely as short-term or long-term losses in succeeding years IRC § 1211(b); IRC § 1212(b); 26 CFR § 1.1212-1.

• Basis determination and tax-lot method:

  • Basis is generally cost, adjusted for items such as commissions and splits; proper records of basis are critical for gain/loss computation Publication 551; Instructions for Form 8949.

  • Brokers must report adjusted basis for “covered securities” and default to FIFO for stock unless the customer makes an adequate identification; they report holding period (short vs. long) and wash sale disallowed loss on Form 1099‑B IRC § 6045(g); 2025 Instructions for Form 1099‑B.

• Reporting:

  • Report transactions on Form 8949 and summarize on Schedule D. If 1099‑B shows basis was reported and there are no adjustments, some transactions may be reported directly on Schedule D per instructions Instructions for Form 8949; Instructions for Schedule D.

When Tax-Loss Harvesting Can Be Useful

• Year-end planning when you have realized capital gains:

  • Harvest losses to offset gains, potentially reducing tax on short-term (taxed like ordinary income) and long-term gains (preferential rates). Consider your mix of short vs. long-term items; netting order follows § 1222 IRC § 1222; Instructions for Schedule D.

• Portfolio rebalancing:

  • If you plan to sell appreciated positions for allocation reasons, realizing losses in other positions can neutralize current gain recognition and improve after-tax outcomes Instructions for Schedule D.

• Managing capital loss carryforwards:

  • If you have carryforward losses, timing gains and losses to efficiently utilize them can minimize future tax; you carry forward capital losses indefinitely as defined in § 1212(b) IRC § 1212(b).

• Special asset classes:

  • For digital assets (cryptocurrency, NFTs), gains/losses are generally capital if held for investment. Reporting is similar to securities transactions (Form 8949/Schedule D). Note: brokers will begin reporting digital asset gross proceeds on Form 1099‑DA for 2025 transactions, easing compliance. The wash sale statute applies to “stock or securities,” not digital assets, which can influence loss-harvesting strategies for crypto; confirm asset classification and reporting requirements IRS Digital Assets; IRC § 1091; IRC § 6045(g); 2025 Instructions for Form 1099‑B.

Key Cautions and How to Navigate Them

1. Wash sale rule (stock and securities)

• Rule: A loss is disallowed if you acquire (or enter into a contract or option to acquire) “substantially identical” stock or securities within 30 days before or after the sale that generated the loss (a 61‑day window). The disallowed loss is not lost forever; it is added to the basis of the replacement shares, and holding period tacks per § 1223(3) IRC § 1091(a), (d), (f); 26 CFR § 1.1091‑1; 26 CFR § 1.1091‑2; IRC § 1223(3).

• Practical implications:

  • Avoid buying back the same or substantially identical security during the window. Consider replacement with a similar but not substantially identical security (e.g., a different issuer or fund tracking a different index).

  • Wash sale applies across accounts and includes contracts/options to acquire the security; track all transactions during the 61‑day period IRC § 1091(a), (f); 26 CFR § 1.1091‑1.

• Basis and holding period adjustments:

  • If the loss is disallowed, adjust basis of replacement shares accordingly, increasing basis by the disallowed loss; holding period includes that of the disposed shares IRC § 1091(d); 26 CFR § 1.1091‑2; IRC § 1223(3).

• Reporting and broker statements:

  • Brokers report wash sale disallowed losses on 1099‑B for covered securities. Reconcile amounts in Form 8949; basis adjustments should be reflected 2025 Instructions for Form 1099‑B; Instructions for Form 8949.

• Scenarios:

  • Classic wash sale disallowance:

    • You bought shares at $100, sold at $80 on January 15 for a $20 loss. On February 1 you repurchased substantially identical shares at $90. The $20 loss is disallowed, and your basis in the new shares becomes $110 ($90 cost + $20 disallowed loss); when you later sell, this adjusted basis will reduce the gain 26 CFR § 1.1091‑2, Example 1.

  • Basis decrease scenario:

    • Same facts except you repurchased at $70; basis becomes $90 ($100 original basis decreased by the $10 excess of the $80 sale price over the $70 repurchase) 26 CFR § 1.1091‑2, Example 2.

1. Straddles and loss deferral

• If you hold offsetting positions (a “straddle”), loss recognition can be deferred beyond the wash sale rule. Losses may be disallowed or carried over to the next year to the extent of unrecognized gains in offsetting or successor positions 26 CFR § 1.1092(b)-1T.

• Practical implications:

  • Even if you avoid a wash sale by buying a not-substantially-identical position that offsets risk, straddle rules can still defer losses. Consider risk-offsetting exposure when harvesting losses; unwinding offsetting positions may be necessary to free losses 26 CFR § 1.1092(b)-1T.

• Scenario:

  • You sell a long stock position at a loss but immediately enter a long call that offsets the retained short exposure (or vice versa). If there is unrecognized gain in the offsetting position at year-end, your realized loss can be disallowed for the year and carried forward per straddle rules 26 CFR § 1.1092(b)-1T, Examples.

1. Traders electing mark-to-market (§ 475(f))

• Traders in securities who validly elect mark-to-market treat securities as sold at fair market value at year-end, recognizing ordinary gains/losses; wash sale rules don’t apply to traders using mark-to-market (except for investment holdings) Topic No. 429.

• Practical implication:

  • If you qualify and elect, loss-harvesting becomes less relevant because losses are ordinary and not subject to capital loss limits or wash sales (for trading inventory). However, the election timing and method changes require compliance and may affect future flexibility Topic No. 429.

1. Asset classes and “substantially identical” securities

• Wash sale’s “substantially identical” standard is facts-and-circumstances; distinct issuers or materially different funds can help avoid wash sale issues. Options or contracts to acquire the same stock count; buying a different asset class (e.g., a sector ETF vs. single-stock) may avoid the rule, but assess similarity carefully IRC § 1091(a), (f); 26 CFR § 1.1091‑1.

1. Recordkeeping and reconciliation

• Keep basis records (purchase dates, costs, and adjustments), and reconcile Forms 1099‑B with Form 8949. Brokers use FIFO and report wash sale disallowance for covered securities; you may make specific lot identifications with the broker to control gains/losses. Report basis and holding period accurately IRC § 6045(g)(2); Instructions for Form 8949; 2025 Instructions for Form 1099‑B.

Scenario Walkthroughs

• Scenario A: Offsetting year-end mutual fund gains

  • Facts: You realized $12,000 of long-term gains from mutual fund redemptions in October. In December, you hold stock lots with $10,000 unrealized losses (mixed short-term and long-term).

  • Plan: Sell the loss positions to generate $10,000 of capital losses; netting under § 1222 will reduce your net capital gains to $2,000. If you have additional losses, up to $3,000 can offset ordinary income; excess carries forward IRC § 1222; IRC § 1211(b); IRC § 1212(b).

  • Caution: Avoid wash sales. Do not repurchase the same stock or substantially identical securities within the 61-day window. Consider similar, but not substantially identical, exposures to maintain market exposure IRC § 1091; 26 CFR § 1.1091‑1.

• Scenario B: Crypto loss harvest (digital assets)

  • Facts: You hold cryptocurrency purchased at $60,000, now worth $40,000, and you wish to maintain exposure.

  • Plan: Sell to realize the $20,000 capital loss and immediately buy a different digital asset or even the same asset (subject to market and strategy).

  • Caution: The statutory wash sale rule applies to “stock or securities.” Digital assets are reported as property and capital assets; brokers will begin reporting proceeds on Form 1099‑DA for 2025. The wash sale statute in § 1091 does not extend to digital assets as “stock or securities.” Ensure proper reporting on Form 8949/Schedule D and comply with new broker reporting as applicable IRS Digital Assets; IRC § 1091; 2025 Instructions for Form 1099‑B.

• Scenario C: Wash sale basis adjustment with stock repurchase

  • Facts: You sold stock at a $1,000 loss on January 3; you repurchased substantially identical stock on January 20 in the same account while wanting to keep exposure.

  • Result: The $1,000 loss is disallowed under § 1091; your basis in the new shares increases by $1,000; holding period tacks IRC § 1091(d); 26 CFR § 1.1091‑2; IRC § 1223(3).

• Scenario D: Straddle deferral

  • Facts: You are short an ETF and buy deep-in-the-money calls to hedge; you close the short at a loss while the calls have unrecognized gain at year-end.

  • Result: Under straddle rules, the loss is deferred to the next year to the extent of unrecognized gain in offsetting/successor positions. Coordinate positions to avoid unintended deferral 26 CFR § 1.1092(b)-1T.

• Scenario E: Trader mark-to-market election

  • Facts: You are a trader in securities and consider § 475(f) mark-to-market.

  • Result: If you timely and validly elect, you recognize ordinary gains/losses on trading positions at year-end; wash sale rules do not apply to trading positions under mark-to-market. This changes the calculus of tax-loss harvesting and removes the $3,000 capital loss limitation for those positions (investment holdings are treated separately) Topic No. 429.

Operational Tips

• Control tax lots and holding periods:

  • Use adequate identification with your broker (instead of FIFO) to select lots with the most favorable tax outcomes; brokers default to FIFO absent identification IRC § 6045(g)(2).

• Watch the 61-day wash sale window:

  • Track purchases and sales (including options) 30 days before and after the loss sale; avoid contracts to acquire substantially identical securities during that period IRC § 1091; 26 CFR § 1.1091‑1.

• Avoid unintended straddles:

  • An offsetting position with unrecognized gain can defer your loss even without a wash sale. Coordinate closing trades and hedges to avoid deferral 26 CFR § 1.1092(b)-1T.

• Report accurately:

  • Reconcile 1099‑B (or 1099‑DA for digital assets) with Form 8949 and Schedule D. Accurately reflect basis, wash sale adjustments, and holding periods. Keep robust records of basis and adjustments Instructions for Form 8949; 2025 Instructions for Form 1099‑B; IRS Digital Assets.

Conclusion

Tax-loss harvesting can materially improve after-tax returns, but its benefits depend on careful netting of capital items, strategic lot selection, and strict compliance with wash sale and straddle rules. For securities, avoid repurchases of substantially identical positions within the wash sale window and be mindful of risk-offsetting positions that trigger straddle loss deferral. For traders, the § 475(f) mark-to-market regime changes the loss landscape entirely. For digital assets, current rules treat them as property for capital gains reporting; apply loss-harvesting cautiously while monitoring evolving broker reporting. Finally, maintain detailed records and reconcile broker statements to properly report transactions on Form 8949 and Schedule D IRC § 1091; 26 CFR § 1.1091‑1; 26 CFR § 1.1091‑2; 26 CFR § 1.1092(b)-1T; IRC § 1211(b); IRC § 1212(b); IRC § 1222; Instructions for Schedule D; Instructions for Form 8949; 2025 Instructions for Form 1099‑B; IRS Digital Assets; Topic No. 429.