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How to Save Money with Tax-Gain Harvesting

If you have winners in your portfolio, conventional wisdom says to delay collecting your capital gains as long as possible. Doing so allows you to defer paying capital gains taxes—plus, waiting could reduce the amount of tax you ultimately owe if you find yourself in a lower bracket when you do sell.

However, conventional wisdom can sometimes be wrong: By selling some of your winners, you could actually help reduce future taxes and create a more balanced portfolio—a strategy known as tax-gain harvesting.

How it works:

Tax-gain harvesting offers investors the opportunity to realize long-term capital gains with little or no impact to their taxes. Here are three situations in which it may be an applicable strategy.

1. You fall into a lower tax bracket this year

If your pay fluctuates from year to year—which may be the case if you’re self-employed, on sabbatical, or work part-time—a lean year could provide an opportunity to realize tax-free long-term gains. Individuals who have taxable income of less than $40,000 ($80,000 for married couples) in 2020 fall into the 0% long-term capital gains tax bracket (LTCG).

In this situation, you would look to realize just enough long-term gains to stay within the 0% tax bracket. For example, if you’re married and your combined taxable income for 2020 is $72,000—wages of $96,800 less the $24,800 standard deduction—you could realize up to $8,000 in long-term gains at the 0% rate. Note that this applies only to long-term capital gains; short-term gains on assets held one year or less are taxed as ordinary income.

Tax-gain harvesting

 

This example is hypothetical and for illustrative purposes only.

 

2. You want to offset losses

Even if you have an income that pushes you into a higher long-term capital gains tax bracket, you can still utilize tax-gain harvesting. For example, if you’ve realized capital losses this year, consider realizing the commensurate amount of gains. The losses effectively zero out the gains, likely eliminating the capital gains taxes that might otherwise be due.

Similarly, if you don’t immediately need the proceeds from the sale, you could consider repurchasing the same stock to reset the investment’s cost basis. That way, you would pay no tax on the current gain—and any realized capital gain in the future would be based on the new, higher cost basis. That said, if you repurchase the same stock, be aware that each and every share needs to be sold for a gain or else the wash-sale rule could apply (see “Beware the wash-sale rule,” below).

Tax-gain harvesting in action

Selling an investment for a gain and resetting its cost basis can help you save on taxes. Let’s look at an example of how tax-gain harvesting works, using the same married couple as before, with $72,000 of taxable ordinary income. Say they also own XYZ stock, which they purchased for $5,000 several years ago and they plan on selling that stock when it hits $15,000, at which point their likely to be in the 15% LTCG tax bracket. They have two options:

tax-gain harvesting chart

This example is hypothetical and for illustrative purposes only.

 

3. You’re looking to reduce concentrated positions

Sometimes your winning positions can throw off your portfolio’s target asset allocation, due to one set of stock raising faster than another. For example, say your tech stocks are doing better than your energy stocks, that could leave you overexposed to volatility in the tech sector and expose you to more market risk than you’d intended. Look for opportunities to bring your portfolio back to its target allocation by selling some winners—ideally along with some losers to help soften the tax hit—and using the proceeds to rebalance your portfolio.

Other considerations

Tax-gain harvesting can only be done in a taxable account, like a brokerage account. Also, recognizing a net capital gain could impact other tax calculations that look at your modified adjusted gross income (MAGI), such as the taxation of Social Security benefits.

Finally, unlike tax-loss harvesting, which can be done year-round, tax-gain harvesting is best implemented at year end, when your total income and losses can be better estimated. That way, you can be sure you’ll indeed qualify for the 0% long-term capital gains tax rate or that you have enough capital losses to offset the realized gains.

The bottom line

By strategically harvesting gains in certain tax years, you can potentially reduce your tax liability and keep your portfolio in balance. Be sure to consult your financial advisor and tax professional to implement a strategy that works for your situation.

Beware the wash-sale rule

A wash sale occurs when you sell a security at a loss and then purchase the same or “substantially identical” security 30 days before or after the sale date.

  • In tax-loss harvesting, investors need to avoid wash sales, or the harvested loss won’t be allowed as a deduction.
  • In tax-gain harvesting, however, the wash-sale rule doesn’t apply if the investor sells every share for a gain and none at a loss. Under that scenario, the investor can immediately repurchase the exact same investment.

 

What You Can Do Next

Important disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when a nonretirement account is rebalanced, taxable events may be created that may affect your tax liability.

This material is approved for retail investor use only when viewed in its entirety. It must not be forwarded or made available in part.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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