Understanding Tax Gain Harvesting
When we think about tax planning within an investment portfolio, the concept of “harvesting” often comes up. Typically, this is in the context of tax loss harvesting, where investors sell assets at a loss to offset gains and reduce their taxable income. However, there’s another, often overlooked strategy called tax gain harvesting. Instead of selling assets at a loss, investors purposely sell assets at a gain—but under very particular conditions designed to minimize or even eliminate the tax bill.
In this post, we’ll break down what tax gain harvesting is, why it might be beneficial, and the key factors to consider before integrating it into your financial plan.
What Is Tax Gain Harvesting?
Tax gain harvesting is the process of selling investments that have appreciated in value when you are in a low (or zero) capital gains tax bracket. By doing so, you “lock in” the gains without incurring significant tax consequences. Afterwards, you can reinvest the proceeds, effectively “resetting” the cost basis of that investment to a higher figure—potentially reducing future tax bills.
This approach can be particularly appealing for retirees or those temporarily in a lower income year. For example, individuals who find themselves in a zero percent long-term capital gains tax bracket may be able to realize gains at no tax cost, thus stepping up their basis and lowering the tax burden when they eventually need to tap into these assets during higher-income years.
How Does Tax Gain Harvesting Work?
Identify Low-Tax Years:
To make tax gain harvesting effective, you must be in (or close to) a zero or low long-term capital gains tax bracket. For U.S. investors, the IRS sets capital gains rates based on taxable income. For some taxpayers, long-term capital gains (on assets held longer than a year) can be taxed at 0% if their income falls below a certain threshold. This scenario might occur if you’re taking a sabbatical, experiencing a temporary reduction in income, or recently retired and have yet to start drawing from retirement accounts or pensions.Sell Appreciated Assets Deliberately:
Next, you choose which appreciated assets to sell. The goal is to realize enough gains to “fill up” the available zero (or low) capital gains bracket without pushing your taxable income into a higher tax rate.Reinvest to Reset Your Cost Basis:
After selling, you then rebuy the same asset. By doing so, you effectively raise your cost basis to the current market price. Later down the road, if you sell the investment at a higher price while you’re in a higher bracket, you’ll owe less in capital gains tax because your starting basis is higher. While not generally applicable to tax gains, it is always important to be mindful of wash-sale rules.
The Benefits of Tax Gain Harvesting
1. Lower Future Taxes:
By increasing the cost basis of your securities while paying little to no taxes on the current gains, you set yourself up for a smaller tax bill when you eventually liquidate those assets in a higher-income year.
2. Strategic Asset Management During Income Transitions:
For individuals who anticipate changes in their income—such as early retirees not yet receiving Social Security, younger investors taking a career break, or anyone expecting large but delayed sources of income—tax gain harvesting provides a window of opportunity to optimize long-term tax efficiency.
3. Portfolio Simplification:
Harvesting gains might also be an opportunity to streamline or rebalance your portfolio. If you’ve been hesitant to sell certain overgrown positions due to tax implications, a low-income year gives you a tax-efficient way to realign your asset mix.
Considerations and Potential Drawbacks
1. Timing and Income Projections:
Accurate forecasting of your income is crucial. Misestimating your income and pushing yourself into a higher bracket by selling too many assets can negate the strategy’s benefits.
2. Tax-Law Awareness:
Tax regulations can change, and state tax laws may differ from federal law. Always consult with a tax professional or financial advisor who understands the current legal landscape and your unique situation.
3. Opportunity Costs:
Selling and repurchasing assets involves transaction costs (if applicable) and the risk of markets moving during the transaction window. While many brokerage firms have minimal trading fees today, it’s still important to consider any potential slippage between selling and buying.
Who Might Benefit Most?
Early Retirees: Individuals between leaving the workforce and starting mandatory retirement distributions (like required minimum distributions from IRAs) may have several low-income years.
Sabbatical Takers or Career Changers: Those who step away from full-time work for a period might find themselves in a lower tax bracket temporarily.
Young Investors With Variable Income: Freelancers, entrepreneurs, or investors whose income can vary significantly from year to year can take advantage of “down” years to realize gains tax-efficiently.
Working With a Professional
Tax gain harvesting can be a powerful component of a comprehensive tax and investment strategy, but it’s not one-size-fits-all. Before taking action, it’s wise to work closely with a financial advisor who can help you:
Determine your eligibility for the 0% capital gains bracket.
Estimate the correct amount of gains to realize without pushing you into a higher bracket.
Ensure you comply with all tax regulations, including any relevant wash sale rules or other considerations.
Final Thoughts
While tax loss harvesting often gets the spotlight, tax gain harvesting is an equally valuable tool for the right investor at the right moment. By strategically realizing gains in a low or zero-tax environment, you can reposition your portfolio, raise your asset cost basis, and set yourself up for greater tax efficiency later on. As with any tax strategy, careful planning, professional guidance, and staying informed about current tax laws are key to making the most of this opportunity.
Disclosure:
Fortress Financial Group LLC (“FFG") is a registered investment advisor. Advisory services are only offered to clients or prospective clients where FFG and its representatives are properly licensed or exempt from licensure. For current FFG information, please visit the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov by searching with FFG’s CRD# 315329.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
The information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
