Common Mistake #34: Not Using Tax-Loss Harvesting to Offset Investment Taxes

Investment taxes rarely feel optional. Gains are realized, forms arrive, and taxes are paid. Yet US tax rules allow investors to offset some of those taxes through losses already sitting in their portfolios. According to IRS guidelines, realized capital losses can be used to offset capital gains, and up to $3,000 per year can be applied against ordinary income, with unused losses carried forward indefinitely.

Despite this, many investors pay higher taxes than necessary simply because losses are ignored. This article explains why failing to use tax-loss harvesting is a common but underutilized mistake, how it increases tax drag over time, and why it often goes unaddressed even by otherwise diligent investors.

Key takeaways

• Tax-loss harvesting can reduce current and future tax liabilities.
• Losses have value even when investments recover later.
• Unused losses don't expire-they accumulate.
• The benefit is structural, not dependent on market direction.
• Taxes compound just like returns.

Why realizing losses feels like admitting failure

Selling an investment at a loss feels uncomfortable. Losses feel personal, even when they're part of a diversified strategy. Many investors prefer to "wait it out", hoping prices recover so the loss disappears on paper.

There's also a psychological mismatch. Gains feel real. Losses feel temporary. Locking them in feels premature.

Up to this point, avoiding realized losses feels patient - maybe even disciplined.

That's why this mistake persists. This tendency is often reinforced when investors continue adding to losing positions, assuming that averaging down will eventually erase the loss. In some cases, prices recover; in others, the position remains impaired for years, delaying both recovery and the ability to use the loss for tax purposes. During that time, the tax benefit exists only in theory, not in practice.

Here's the part most investors overlook

Losses don't disappear just because prices recover. They either remain unrealized or they become tax assets.

When losses are realized, they can be used to:

• Offset capital gains dollar-for-dollar
• Reduce taxable income by up to $3,000 per year
• Carry forward to offset future gains without expiration

So what? Ignoring losses doesn't preserve value-it forfeits optionality.

This is where emotional framing obscures financial mechanics.

This is where taxes quietly become a performance drag

Hypothetical example: Imagine two investors with identical portfolios and identical market returns. One periodically realizes losses and carries them forward. The other never does.

Over time, both generate gains. But one consistently offsets taxes using previously realized losses. The other pays full capital gains taxes whenever positions are sold.

The difference doesn't show up as underperformance in the portfolio. It shows up as higher taxes paid to achieve the same return.

Nothing dramatic happens in any single year. The drag accumulates quietly.

Why market volatility makes this mistake more costly

Market downturns create losses. Many investors see those periods as setbacks.

From a tax perspective, volatility creates opportunities.

Losses realized during downturns can be used years later, when gains occur under very different market conditions. This disconnect is often missed. Investors think harvesting only "matters" if they have gains right now.

In reality, tax-loss harvesting isn't about timing markets. It's about banking offsets.

This is where short-term discomfort can produce long-term efficiency.

Why is this strategy commonly ignored

Several factors keep investors from using tax-loss harvesting:

• Emotional reluctance to sell at a loss
• Uncertainty about wash-sale rules
• Focus on pre-tax returns rather than after-tax outcomes
• Lack of visibility into cumulative tax impact

Behavioral research in finance and economics shows that investors often segregate financial outcomes into separate mental categories - a phenomenon known as mental accounting - and may treat taxes as a discrete, annual event rather than as a recurring cost embedded in investment returns. This cognitive framing can cause them to underweight the ongoing impact of taxes when making portfolio decisions

The result is higher friction that goes unchallenged.

The reframe that changes the decision

Investors who use tax-loss harvesting effectively often adopt a simple reframe:

Losses are tax assets, not verdicts on investment skill.

This reframing separates investment decisions from tax mechanics.

Supporting considerations-such as understanding wash-sale restrictions or tracking carried-forward losses-exist to inform decisions, not to force constant activity.

The goal isn't trading more. It's wasting less.

When tax-loss harvesting may not apply

Tax-loss harvesting is not universally relevant. It generally applies to taxable investment accounts, not tax-advantaged ones like IRAs or 401(k)s. Some investors also prioritize simplicity or have limited realized gains to offset.

As with other mistakes in this series, the distinction is awareness.

Failing to use tax-loss harvesting becomes costly when losses go unrecognized and unused, not when the strategy is consciously set aside.

Taxes don't require perfection. They reward attention.