Selling a stock at a loss, sometimes called tax harvesting, can help you lower your obligation at tax time. This strategy works because stocks are defined as capital assets by the Internal Revenue Service (IRS). If you sell stock (or any capital asset) for profit, you pay capital gains taxes on the money you earned, and if you lose money, you can deduct the full amount of that loss.

For example:

--  If you bought 100 shares of ABC Company for $50 per share ($5,000 total) and sold them for $55 per share ($5,500 total), you would have to pay taxes on the $500 earned.

--  If you bought 100 shares of DEF Company for $50 per share ($5,000 total) and sold them for $45 per share ($4,500 total), you could deduct the $500 loss on your taxes.

This ability to turn investment loss into tax relief has led to the process of tax harvesting, whereby investors compute their capital gains and try to sell off stock to create an equal loss. From our example above, the $500 in capital gains made from selling ABC’s stock is offset by the $500 loss from selling DEF’s stock. This investor effectively pays no taxes on the $500 profit.

However, keep one important caveat in mind. The federal government does not want investors selling stock for a loss one day and buying the stock back the next, just so they can claim a deduction. To avoid this situation,”wash sales” were created.

The rules for wash sales are somewhat complicated; however, in general, if investors repurchase a stock they sold for a loss within 30 calendar days of that sale, the transactions are together considered to be a wash sale. In other words, if you sell your stock on April 1, you cannot buy the stock again until May 1, or the sale is considered a wash sale. A wash sale makes figuring your profit or loss more difficult in the future.