Taxes can eat into your investment returns, but smart tax strategies can help long-term investors minimize their liabilities and keep more of their hard-earned money. Two key tax strategies — tax-loss harvesting and the step-up in basis rule—can significantly impact how much you owe in taxes and how much wealth you pass on to your heirs.
In this article, we’ll break down how tax-loss harvesting works, when to use it (and when not to), the IRS wash sale rule, and how the step-up in basis rule benefits heirs in estate planning. By understanding these tax strategies, you can optimize your investments for long-term gains while reducing unnecessary tax burdens.
What is Tax-Loss Harvesting?
How It Works
Tax-loss harvesting is a strategy where investors sell underperforming stocks or assets at a loss to offset taxable capital gains. This can reduce your tax bill by lowering your net capital gains for the year.
For example, suppose you:
- Sold Microsoft (MSFT) stock at a $5,000 profit.
- Sold Tesla (TSLA) stock at a $3,000 loss.
By applying tax-loss harvesting, your taxable capital gain is reduced to $2,000 instead of $5,000, lowering your tax liability.
Short-Term vs. Long-Term Gains Impact
The IRS taxes capital gains differently based on how long you hold an investment:
- Short-term capital gains (held less than 1 year): Taxed at your ordinary income tax rate (up to 37%).
- Long-term capital gains (held more than 1 year): Taxed at a lower rate (0%, 15%, or 20% depending on your income).
Tax-loss harvesting is especially valuable for offsetting short-term capital gains, since those are taxed at higher rates.
Can You Offset Ordinary Income with Losses?
Yes! If your capital losses exceed your capital gains, you can deduct up to $3,000 ($1,500 if married filing separately) from your ordinary income per year. Any remaining losses can be carried forward to future years.
The IRS Wash Sale Rule Explained
The IRS wash sale rule prevents investors from selling a stock at a loss and rebuying it within 30 days to claim a tax deduction. If you violate this rule, the loss is disallowed for tax purposes.
Example of a Wash Sale Violation
- You buy 100 shares of Apple (AAPL) at $180 per share.
- The stock drops to $150, and you sell it to claim a $3,000 loss.
- A week later, you repurchase 100 shares of AAPL at $155.
Since you bought back the same stock within 30 days, the IRS disallows your loss for tax purposes.
How to Avoid the Wash Sale Rule
- Wait 31+ days before rebuying the same stock.
- Buy a similar (but not identical) asset.
- Example: Instead of rebuying TSLA, you could buy Ford (F) or General Motors (GM) if you want EV exposure.
- Harvest losses in a different asset class.
- If you sell a losing stock, consider reinvesting in an ETF or mutual fund in the same sector.
💡 Related Reading: The Ultimate Tax Guide for Long-Term Investors
When to Use Tax-Loss Harvesting (and When Not To)
When It’s a Smart Strategy
✅ You have taxable capital gains this year. Selling a losing stock can offset gains and reduce your tax bill.
✅ You want to rebalance your portfolio. Selling underperforming stocks and reinvesting elsewhere helps optimize your holdings.
✅ You’re in a high tax bracket. Tax-loss harvesting is most effective when your capital gains tax rate is high.
When You Should Avoid It
❌ If you don’t have any capital gains to offset. Carrying forward losses can help in future years, but you might not benefit immediately.
❌ If you’re selling strong long-term stocks. Avoid selling quality companies at a loss just for tax benefits—hold great stocks for the long run.
❌ If it triggers a wash sale. Ensure you follow IRS rules to avoid disallowed losses.
💡 Related Reading: Tax-Efficient Investing: Maximizing Returns by Minimizing Tax Liabilities
The Step-Up in Basis Rule: A Major Tax Advantage for Heirs
How It Works
When someone inherits stocks, real estate, or other investments, the cost basis of the asset is “stepped up” to its market value at the time of inheritance. This can eliminate capital gains taxes on past appreciation.
Example of Step-Up in Basis
- Original Purchase Price: Your grandfather bought 100 shares of Amazon (AMZN) at $50 per share ($5,000 total).
- Value at Inheritance: When he passes away, AMZN is worth $150 per share ($15,000 total).
- Your New Cost Basis: Instead of inheriting his original $50 per share basis, your cost basis is stepped up to $150 per share.
- Tax Savings: If you sell at $160 per share, you only owe capital gains tax on $10 per share ($160 – $150)—not on the full gain from $50 per share!
Why It’s Important for Estate Planning
✅ Eliminates capital gains taxes on past appreciation
✅ Allows heirs to inherit stocks tax-efficiently
✅ Encourages long-term investing without tax penalties
Will the Step-Up in Basis Rule Change?
There have been legislative proposals to limit or eliminate the step-up in basis rule, but as of 2025, it remains in place. Investors should stay informed about any potential tax law changes that could impact estate planning.
Key Takeaways & Action Steps
✅ Tax-Loss Harvesting Tips:
- Use tax-loss harvesting to offset capital gains and ordinary income.
- Be aware of the IRS wash sale rule—don’t repurchase the same stock within 30 days.
- Consider replacing sold stocks with similar (but not identical) assets to stay invested.
✅ Step-Up in Basis Strategy for Heirs:
- When inheriting assets, your cost basis resets to the market value at inheritance.
- This helps heirs avoid large capital gains taxes on past appreciation.
- Long-term investors should consider estate planning strategies to maximize this tax benefit.
Final Thoughts on Tax-Loss Harvesting and Step-Up in Basis Work
Understanding tax-loss harvesting, the wash sale rule, and the step-up in basis rule can help you invest smarter and reduce your tax burden. Whether you’re looking to minimize capital gains taxes or plan for generational wealth transfer, these strategies can be powerful tools in your investing playbook.
Make sure to review your tax strategy annually and consult a tax professional if needed. By staying informed, you can optimize your investments and keep more of your hard-earned returns.
Happy Investing