Tax Rules for ETF Losses: Wash Sales, Harvesting, and Carryovers

The tax rules for ETF losses let you subtract those losses from your capital gains dollar for dollar, and if losses still exceed gains, you can deduct up to $3,000 of the leftover against ordinary income each year, with anything above that carried forward indefinitely.¹ The catch is that several overlapping rules — holding periods, wash sales, cost basis elections, and special treatment for certain commodity and currency funds — decide whether the deduction actually lands the way you expect.

How the Loss Actually Reduces Your Tax

A loss appears when you sell an ETF for less than your cost basis, which is what you paid for the shares plus any commissions. That loss first cancels out capital gains you realized the same year. The netting follows a specific order: short-term losses offset short-term gains, long-term losses offset long-term gains, and only after that internal netting does a leftover loss in one category cross over to reduce a net gain in the other.¹

If losses still exceed gains after all that, up to $3,000 of the remaining amount comes off ordinary income like wages or interest. The cap is $1,500 for married filing separately.¹ Because that deduction lowers your adjusted gross income, it can also help you qualify for credits and deductions that phase out at higher income levels.

Short-Term and Long-Term Losses

Holding period controls character. Shares held for one year or less produce a short-term loss; more than one year produces a long-term loss.²

The distinction matters because of what the loss is offsetting. Short-term gains are taxed at ordinary income rates. Long-term gains get preferential rates of 0%, 15%, or 20% depending on income. A short-term loss that cancels a short-term gain saves you more per dollar than a long-term loss canceling a long-term gain, simply because the rate on what it’s offsetting is higher. Keep that in mind when you have a choice of which lots to sell.

Choosing Which Shares to Sell

If you bought your ETF in several purchases at different prices, which shares you sell for tax purposes changes the size of your loss. Three IRS-approved cost basis methods are available:

First in, first out (FIFO) treats your earliest-purchased shares as sold first. This is the default if you make no election.
Specific identification lets you designate exactly which lot you’re selling at the time of the trade.
Average cost pools all shares in the position at their average price, and is available for mutual funds and ETFs.

Specific identification gives you the most control, because you can pick the highest-basis lot to maximize the loss. You have to identify the lot before the trade executes and keep records. Most brokerages let you set a default method in your account settings; changing it later only affects future sales.

The Wash Sale Rule

Sell an ETF at a loss and buy the same or a substantially identical security within 30 days before or after that sale, and the loss is disallowed under the wash sale rule.³ The window runs 30 days in both directions plus the sale date, so 61 days total.

The disallowed amount isn’t lost. It gets added to the cost basis of the replacement shares, so you recover it when you eventually sell those shares in a clean transaction. The holding period of the original shares also tacks on to the replacement shares, which means the clock for short-term versus long-term doesn’t restart.⁴

What Counts as Substantially Identical

The IRS has never published a bright-line definition of “substantially identical” for ETFs. Two funds from different providers that track the same index — say, an S&P 500 fund from Vanguard and one from iShares — are widely treated as substantially identical because they hold the same stocks in the same proportions. Swapping between them at a loss would likely trigger the rule.

The picture changes when the underlying indexes differ. Selling an S&P 500 fund and buying a total stock market fund or a Russell 1000 fund is generally not a wash sale, even though the holdings overlap. What matters is whether the funds track the same index, not whether they share individual stocks. The IRS evaluates this on a facts-and-circumstances basis, so the further apart two funds are in construction, the safer the swap.

IRA and Spouse Traps

The wash sale rule reaches beyond your taxable brokerage account. If you sell an ETF at a loss in a taxable account and buy a substantially identical fund in your IRA or Roth IRA inside the 61-day window, the loss is disallowed.⁵ Worse, the disallowed loss does not increase the basis of the IRA shares. That loss is effectively gone for good.⁶

The rule also catches purchases by your spouse. If your spouse buys a substantially identical fund in any of their accounts inside the 61-day window, your loss is disallowed.⁷ This is easy to overlook when both spouses have automatic dividend reinvestment turned on.

Tax-Loss Harvesting

Tax-loss harvesting means deliberately selling ETFs at a loss to capture the deduction, then reinvesting in a similar but not substantially identical fund so you stay in the market. Selling a large-cap U.S. equity ETF tracking one index and buying one that tracks a different large-cap index books the loss without leaving your target allocation.

Pick a replacement that fills the same role in your portfolio so your asset allocation doesn’t drift. After the 31-day window closes, you can buy the original fund back if you prefer it. The cost basis on the replacement shares reflects your new, lower purchase price, so the loss is deferred rather than eliminated. What you gain is the time value of money: a deduction today is worth more than the same deduction years from now.

Carrying Losses Into Future Years

Net losses above the $3,000 annual limit against ordinary income carry forward to the next year. There’s no expiration and no ceiling on the carryover balance.⁸ Carried-over losses keep their original character: a short-term carryover stays short-term, and a long-term one stays long-term. Each year you combine the carryover with that year’s new gains and losses, run through the same netting, and deduct up to $3,000 of any remaining net loss. The cycle repeats until the balance is zero.

The IRS provides a Capital Loss Carryover Worksheet in the Schedule D instructions to track these amounts.⁹ Keep a copy with your records, because your broker doesn’t track carryovers for you. If you lose the thread, you’ll have to reconstruct the balance from prior-year returns.

One boundary to know: capital loss carryovers can only be deducted on the taxpayer’s final income tax return. They cannot pass to a surviving spouse, an estate, or any beneficiary.¹⁰ Someone dying with $50,000 in accumulated carryovers and $2,000 of capital gains on their final return offsets the $2,000 and deducts another $3,000 against ordinary income; the remaining $45,000 disappears. For older investors with large carryover balances, realizing gains in appreciated positions during their lifetime is one way to put the losses to use.

Special Rules for Commodity and Currency ETFs

Not every ETF is taxed like a stock fund. Structure controls the rules.

Commodity ETFs organized as partnerships that hold futures contracts fall under Section 1256’s mark-to-market rules. Gains and losses on the underlying contracts are taxed at a blended rate: 60% long-term and 40% short-term, regardless of how long you actually held the fund. These funds issue a Schedule K-1 rather than a Form 1099-B, which can complicate and delay your filing.

Commodity ETFs that hold the physical metal, like gold or silver bullion trusts, are treated as collectibles. Long-term gains on collectibles are taxed at a maximum rate of 28%, higher than the 20% ceiling on stocks and equity ETFs. Losses still offset gains normally, but the higher rate on future gains is worth knowing before you assume a swap between a bullion ETF and an equity ETF is an apples-to-apples trade.

ETF Losses and the Net Investment Income Tax

Higher-income taxpayers pay a 3.8% surtax called the Net Investment Income Tax on investment income above certain thresholds: $200,000 for single filers, $250,000 for married filing jointly, and $125,000 for married filing separately.¹¹ Those thresholds are not indexed for inflation.

ETF losses reduce net investment income, which can shrink the amount hit by the 3.8% tax or push you below the threshold entirely. On $30,000 in capital gains offset by $20,000 in ETF losses, only $10,000 counts as net investment income. For a taxpayer already over the threshold, that $20,000 loss saves an extra $760 in NIIT on top of the regular capital gains tax savings.

Reporting the Loss on Your Return

Your broker reports each ETF sale on Form 1099-B, showing the sale date, proceeds, cost basis, and whether the transaction is short-term or long-term.¹² Check the reported cost basis against your own trade confirmations. Errors are common on shares purchased before 2012 or transferred between brokerages.

The 1099-B data transfers to Form 8949, where each sale gets its own line.¹³ Wash sale adjustments go on the same line with a specific code and the disallowed amount in the adjustment column. Short-term and long-term transactions are reported in separate sections of the form.

Totals from Form 8949 flow to Schedule D, where you calculate the year’s net gain or loss, apply the $3,000 ordinary income deduction limit, and pull in any prior-year carryover.⁹ If you’re carrying losses in, you’ll need the previous year’s Capital Loss Carryover Worksheet to fill in lines 6 and 14 correctly.

1
Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
2
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
3
Office of the Law Revision Counsel. 26 US Code 1091 – Loss From Wash Sales of Stock or Securities
4
Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
5
Internal Revenue Service. Rev. Rul. 2008-5
6
Internal Revenue Service. Internal Revenue Bulletin 2008-3
7
Internal Revenue Service. Publication 550 (2025), Investment Income and Expenses
8
Office of the Law Revision Counsel. 26 US Code 1212 – Capital Loss Carrybacks and Carryovers
9
Internal Revenue Service. 2025 Instructions for Schedule D (Form 1040)
10
Internal Revenue Service. Publication 559 (2025), Survivors, Executors, and Administrators
11
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
12
Internal Revenue Service. About Form 1099-B, Proceeds From Broker and Barter Exchange Transactions
13
Internal Revenue Service. Instructions for Form 8949 (2025)