In December 2022, an investor held $40,000 in unrealized losses across several tech positions after the market downturn. She sold those positions, immediately bought similar (but not substantially identical) ETFs to maintain market exposure, and used the $40,000 in realized losses to offset $40,000 in gains she had taken earlier that year. At a 15% long-term rate, this saved her $6,000 in federal tax — money she reinvested.

She stayed fully invested in the same sector the entire time. The tax code effectively paid her $6,000 for doing paperwork. Tax-loss harvesting is the deliberate realization of paper losses to create a tax deduction — while staying invested in the market.

You sell the losing position, book the loss on your tax return, and buy a replacement that gives you similar exposure. The loss offsets gains dollar-for-dollar. If your losses exceed your gains, you can deduct up to $3,000 per year against ordinary income, carrying the rest forward indefinitely.