Quick Answer: Tax-loss harvesting is the practice of selling investments at a loss to offset capital gains and reduce your taxable income. For 2026, small business owners and individual investors can use realized capital losses to offset realized capital gains dollar-for-dollar, with up to $3,000 of excess losses deductible against ordinary income each year.
What Is Tax-Loss Harvesting?
Tax-loss harvesting is a year-end tax planning strategy where you intentionally sell underperforming investments — stocks, bonds, mutual funds, or other securities — to realize a capital loss. That realized loss can then be used to offset realized capital gains from other investments, reducing your overall tax liability. If your capital losses exceed your capital gains, you can deduct up to $3,000 of the net loss against ordinary income ($1,500 if married filing separately), with any remaining loss carried forward to future tax years.
For small business owners who hold a portfolio of business or personal investments, this strategy can meaningfully reduce their annual tax bill — but it must be executed carefully to avoid the wash-sale rule and other traps.
How Capital Gains and Losses Work
Before diving into harvesting, it is essential to understand how gains and losses are classified. Capital gains and losses fall into two categories:
- Short-term — Assets held for one year or less. Short-term gains are taxed at ordinary income tax rates, which in 2026 range from 10% to 37% depending on your income bracket.
- Long-term — Assets held for more than one year. Long-term gains are taxed at preferential rates: 0%, 15%, or 20%, depending on taxable income.
Losses offset gains in a specific order: short-term losses first offset short-term gains, and long-term losses first offset long-term gains. Any excess in one category can then offset gains in the other. Because short-term gains are taxed at higher rates, prioritizing the offset of short-term gains provides the greatest tax benefit.
Step-by-Step: How to Harvest Tax Losses
1. Review Your Portfolio Before Year-End
The most common time for tax-loss harvesting is the fourth quarter — typically November and December — but it can be done at any point during the year. Start by identifying positions that are trading below your cost basis. Your brokerage statement or portfolio tracker should show unrealized gains and losses for each holding.
2. Identify Offsetting Gains
Next, review any realized gains from earlier in the year — for example, profits taken on the sale of a business asset, stock, or real estate. The goal is to realize enough losses to neutralize as much of those gains as possible. If you have no realized gains, you can still harvest losses to claim the up-to-$3,000 ordinary income deduction.
3. Execute the Sale (and Beware the Wash-Sale Rule)
Once you identify a losing position, sell it to realize the loss. But here is the critical rule: do not repurchase the same or a "substantially identical" security within 30 days before or after the sale. This is the wash-sale rule (IRC Section 1091). If you violate it, the loss is disallowed and added to the cost basis of the replacement shares instead.
To maintain market exposure without triggering the wash-sale rule, many investors immediately purchase a similar but not identical security — for example, selling one S&P 500 ETF and buying a different one that tracks a different index, or selling an individual stock and buying an ETF in the same sector.
4. Document Everything
Keep records of the sale date, purchase date, cost basis, sale proceeds, and the resulting gain or loss. Your broker will issue Form 1099-B, but having your own records ensures you can reconcile the numbers and substantiate the transactions if audited. This is especially important for surviving a tax audit.
Wash-Sale Rule: The #1 Pitfall
The wash-sale rule is the most common reason tax-loss harvesting strategies fail. The 61-day window (30 days before the sale + day of sale + 30 days after) applies to purchases in any account — taxable brokerage, IRA, and even your spouse's account. A few practical tips:
- Do not set up automatic dividend reinvestment on the position you plan to sell — a dividend reinvestment within the 30-day window can trigger a partial wash sale.
- Check all accounts — buying the same stock in your IRA while harvesting the loss in your taxable account still triggers the wash-sale rule.
- "Substantially identical" is broad — selling one share class of a mutual fund and buying another class of the same fund almost certainly triggers the rule. Selling one large-cap ETF and buying a different large-cap ETF from a different provider that tracks a different index is generally considered safe.
Tax-Loss Harvesting for Small Business Owners
Small business owners often have unique opportunities beyond traditional securities:
- Business investments in other entities — If your business holds equity in another company that has declined in value, selling that stake can generate a capital loss.
- Section 1244 stock — If you invested in a small business corporation that failed, you may be able to treat up to $50,000 ($100,000 for joint filers) of the loss as an ordinary loss rather than a capital loss, which is far more valuable.
- Worthless securities — If a security becomes completely worthless, you can claim a capital loss in the year it becomes worthless, even without selling it. This is treated as a sale on the last day of the tax year.
Coordinating with Other Tax Strategies
Tax-loss harvesting works best as part of a broader tax plan. It can be combined with:
- Capital dividend account (CDA) planning — In Canada, the non-taxable portion of capital gains flows into the CDA, enabling tax-free dividends to shareholders. Loss harvesting affects net capital gains and therefore CDA balances.
- Net operating loss (NOL) carryforwards — If your business has NOLs, you may not need to harvest losses in the current year because NOLs already shelter income.
- Retirement account contributions — Maxing out SEP IRA or Solo 401(k) contributions reduces taxable income, which can change which tax bracket your capital gains fall into.
Year-End Checklist for Tax-Loss Harvesting
Use this checklist in November or December to execute your harvesting strategy:
- Review all taxable brokerage and investment accounts for unrealized losses.
- Calculate realized gains year-to-date from all sales.
- Determine how much in losses you need to offset those gains (plus up to $3,000 for ordinary income).
- Identify replacement securities to maintain your target asset allocation without triggering the wash-sale rule.
- Execute the sales before December 31 — trades must settle by year-end for the loss to count in the current tax year.
- Turn off dividend reinvestment on harvested positions through the 30-day post-sale window.
- Document all transactions and update your cost-basis tracking.
Limitations and Risks
While tax-loss harvesting is a legitimate and widely used strategy, it has limitations:
- It defers taxes, not eliminates them — When you sell the replacement security at a gain in the future, your lower cost basis means a larger taxable gain later. The benefit is the time value of money and the potential for the gain to be taxed at a lower long-term rate.
- It only applies to taxable accounts — Losses inside an IRA, 401(k), or other tax-deferred account cannot be harvested.
- Transaction costs and bid-ask spreads — For small positions, trading costs can eat into the tax savings. Make sure the loss is large enough to justify the round-trip transaction.
- The $3,000 annual limit — Net capital losses in excess of gains are capped at $3,000 per year against ordinary income. Large losses may take many years to fully utilize, though they carry forward indefinitely.
Summary
Tax-loss harvesting is one of the most accessible year-end tax strategies for small business owners and individual investors. By selling underperforming positions before December 31, you can offset realized capital gains and deduct up to $3,000 against ordinary income — all while staying invested through similar replacement securities. Just stay clear of the wash-sale rule, coordinate with your broader tax strategy, and keep thorough records. For complex portfolios or large positions, consulting with a CPA before executing the trades is always prudent.
