You realize a capital loss by selling an asset at a lower price that you paid for it. You then purchase the same amount of similar, but not identical assets. Tax loss harvesting laws prevent you from rebuying the exact same stock, but with the plethora of ETFs, it is not hard to find something pretty similar that is not exactly the same. For instance, sell Total US Stock Market, then buy a combo of S&P 500 and Russell 2000. This way you end up with roughly the same investments you had before, but you have realized the capital loss. It is important that you actually do the repurchase part; if you sell and keep your money in cash, then you risk missing out if stocks go up in value after you sell.
You can use the capital loss to offset capital gains and make a limited income deduction each year. You can carry over unused losses to following years. However, although you have the same investment mix as before, you now have a lower cost basis on the new assets. This means that you will eventually have to pay additional capital gains tax on an amount equal to the capital loss you realized. However you don't have to pay this extra tax until you sell the new assets, which could be a long time in the future.
So where is the benefit? It comes in two ways:
1. Presumably when you sell your replacement funds later, you will do it after 1 year, so you pay long-term capital gains tax on it. However, your capital loss can be used to offset short-term capital gains tax and normal income. For most people, the long-term capital gains tax rate is much lower than short-term capital gains and normal income.
2. You end up paying the tax later. This is advantageous because of the time-value of money. $1 today is worth more than $1 is worth 20 years from now.
If you have a realized loss, you get the tax benefits. If you have an unrealized loss, you don't. Either way, your stocks have the same value.
