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  • Writer's pictureTad Jakes

Tax-Gain Harvesting: A Strategy You May Be Overlooking


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If you are a seasoned investor, you are likely familiar with the idea of "tax-loss harvesting," which is a strategy that allows you to reduce your taxable income by selling investments that have declined in value (if you are unfamiliar, please read my article on the subject here).  However, tax-loss harvesting has a lesser-known sibling, a strategy called "tax-gain harvesting" that could potentially help you save on taxes and decrease your portfolio's risk at the same time. 


Yes, you heard me correctly, tax-gain harvesting involves intentionally selling investments that have appreciated, paying tax on the gains (or not depending on your tax bracket), and then reinvesting the proceeds. Common wisdom is generally to hold off on selling appreciated assets to avoid paying capital gains taxes, however, there are situations when harvesting gains can be advantageous. 


In this article, I’ll discuss how tax-gain harvesting works, how it can enhance wealth, and when this strategy should be avoided. 


Understanding the Basics of Tax-Gain Harvesting


Before we explore the details of tax-gain harvesting, it's crucial to understand some basic terms and concepts. Following are some key points to understand before moving on, based upon current tax law:


  • Capital gains refer to the increase in value of an investment over time. When you sell an investment for more than you paid, the result is a “realized” capital gain, which is taxable income. 

  • Capital losses result when you sell an investment for less than the purchase price.   The “realized” capital loss can be used to reduce taxable income. 

  • Long-term capital gains result when you sell an investment that you owned for one year or more and is taxed at the long-term capital gains tax rate (a lower, more favorable rate than ordinary income).

  • Short-term capital gains result from selling an investment that you have held for less than one year.  The gains are taxed the same as ordinary income.

  • Harvesting long-term capital gains does not push you into a potentially higher tax bracket for your ordinary income, but it can push you into a higher capital gains tax rate.  Harvesting short-term capital gains can potentially push you into a higher ordinary income tax bracket and long-term capital gains tax bracket. 

  • Just like tax-loss harvesting, tax-gain harvesting only applies to investments that are held outside of your tax-free or tax-deferred accounts.  If investments are held in a tax-sheltered account, such as a 401(k) or IRA, the following strategies do not apply. 

Now, why would anyone willingly pay taxes before they have to?


Timing is Everything


The key to successfully leveraging tax-gain harvesting is careful timing. Generally, you'll want to harvest gains in years when you expect to be in a lower tax bracket than in the future. If you're in a lower tax bracket now than you expect to be in the future, paying taxes on your gains at today's lower rate can result in significant savings down the line. Furthermore, when you reinvest the proceeds of the sale, you are increasing your cost basis, potentially reducing the amount of taxable gain when you sell the investment in the future.


Below are capital gains tax tables provided by the IRS.  This will provide some context for the strategies we’re about to cover. 


Long-term capital gains tax rates for 2024 based on taxable income

FILING STATUS

0% RATE

15% RATE

20% RATE

Single

Up to $47,025

$47,026 – $518,900

Over $518,900

Married filing jointly

Up to $94,050

$94,051 – $583,750

Over $583,750

Married filing separately

Up to $47,025

$47,026 – $291,850

Over $291,850

Head of household

Up to $63,000

$63,001 – $551,350

Over $551,350

Source: Internal Revenue Service


Don't Forget About the Net Investment Income Tax


The Net Investment Income Tax (NIIT) is an additional tax that high-earning taxpayers must pay on certain net investment income, which includes short and long-term capital gains, dividends, interest, and other investment income. This tax applies to those with modified adjusted gross income over $200,000 for a single filer or $250,000 for a married couple filing jointly. If this tax applies, you'll pay an extra 3.8% in taxes on investment income (including capital gains) above the threshold. These income limits are not indexed for inflation, so more investors may be subject to this additional tax in future years.  Before making any decisions regarding tax-gain harvesting, make sure you factor in the 3.8% NIIT if it applies.


Strategies for Your Capital Gains Tax Bracket


0% Tax Bracket


  • If you are in the 0% long-term capital gains tax bracket, you will pay no tax on long-term capital gains.  This is a rare gift from Congress and the IRS. 

  • If you expect to move into the 15% tax bracket the following year, consider harvesting gains in the current year to increase your cost basis.

  • Harvesting long-term gains will not push you into a higher ordinary income tax bracket but it can potentially push you into a higher long-term capital gains tax bracket, so make sure you understand where your income is in relation to the tax thresholds.

  • Before harvesting gains, make sure you know ahead of time what portion of the gain is long-term, and if any portion of the gain is short-term.  If you harvest short-term gains, you can potentially push yourself into higher tax brackets for both ordinary income and capital gains, which could make for an unpleasant surprise. 


15% Tax Bracket


  • If you are in the 15% capital gains tax bracket and anticipate that you will soon be in the 20% tax bracket (and will likely stay there), you can consider harvesting gains in the current year at the lower rate.  Reinvesting the proceeds will increase your cost basis and minimize capital gains tax due at the higher 20% level.

  • If you anticipate the following year you will be in the 0% capital gains tax bracket, postponing the harvesting of gains could be advantageous.  Instead of paying 15% (or 18.8% if you’re subject to the NIIT), you could potentially pay 0%.


20% Tax Bracket


  • First off, give yourself a pat on the back for your success, but intentionally harvesting gains while in the top tax bracket won’t produce any tax benefit (at least for now based on current tax law, but more on this in a moment).   

  • If you anticipate that your income in the future will drop to the 15% bracket (or even 0%), delaying a sale is worth considering if the need to sell is not imminent.

  • Although tax-loss harvesting could be used in any tax bracket, high earners should be actively looking for tax-loss harvesting opportunities to mitigate the impact of taxes on their wealth.


When You Shouldn’t Use Tax-Gain Harvesting


While tax-gain harvesting is an excellent strategy under the right circumstances, not all investors should leverage it. In some instances, this approach can do more harm than good.  Here are three scenarios in which you should avoid using tax-gain harvesting.


  1. Assets Held for Less than a Year: When tax-gain harvesting, we want to take advantage of the low tax rates for long-term capital gains, not the higher rates for short-term gains.  If you sell appreciated assets held for less than a year, not only will you pay tax at the higher ordinary income tax rate, but you could push yourself into a higher tax bracket for both capital gains and ordinary income. 

  2. Alternative Minimum Tax (AMT): The AMT is an alternative tax calculation required by law for some taxpayers. Depending on your income, selling investments to harvest gains could cause you to owe an alternative minimum tax. Before harvesting your gains, consult with your tax advisor and consider preparing a preliminary tax return to see if the AMT applies to your situation.

  3. Wait for a Step-Up in Basis: When a person passes away leaving appreciated assets to their heirs, the heirs, under current tax law, receive a “step-up” in basis. The new basis is the asset's value as of the date of death, essentially hitting the “reset button” on cost basis.  This has the potential to eliminate substantial capital gains tax.  For example, your 95-year-old grandmother has a $2 million investment portfolio with a basis of $1.1 million.  If sold, she would incur capital gains of $900,000.  However, when she passes away, her heirs will receive the $2 million portfolio and the basis will “step up” to $2 million (or the value on the date of death), potentially saving a significant sum in capital gains tax.   Unless there is a legitimate need to sell appreciated assets, waiting for a step-up in basis could be beneficial.


How to Optimize Your Financial Growth with Tax-Gain Harvesting


Optimizing your financial growth with tax-gain harvesting involves careful planning and strategic decision-making. Here are steps you can take to leverage this strategy effectively:


  1. Understand your tax situation: Before you can effectively leverage tax-gain harvesting, you need to understand your current and future tax situation. This involves knowing your current tax bracket, your anticipated future tax bracket, and the current capital gains tax rates.

  2. Monitor your investments: Keep a close eye on your investments’ performance and cost basis. This will help you identify when it might be a good time to harvest gains or losses or rebalance your portfolio. Brokerage firms are now required to track the cost basis for each of your holdings.  This information is invaluable when deciding to harvest gains or losses (especially if trying to avoid short-term gains).

  3. Keep risk in check: Whether you are rebalancing your portfolio and trimming back on your winners, or trying to reduce exposure from a concentrated stock position, there are times when selling appreciated investments and harvesting those gains is necessary to maintain diversification and keep the risk/return profile of your portfolio in check.  If you are actively employing a tax-loss harvesting strategy at the same time, you can help to reduce the impact of capital gains. 

  4. Consider the impact of state taxes: While federal capital gains tax rates are often the focus of tax-gain harvesting strategies, don't forget about state taxes. Depending on where you live, state capital gains taxes can also significantly impact your overall tax liability.

  5. Don't let taxes drive your investment decisions: While tax-gain harvesting can be a valuable strategy, it's important not to let taxes dictate your entire investment strategy. Always consider your overall financial goals and risk tolerance, risk capacity, and time horizon before making any decisions.

  6. Consult with an investment and/or tax professional: Tax-gain harvesting can be a complex strategy, and it's always a good idea to consult with a tax professional before making any major decisions. They can help you understand the potential tax implications of your actions and can guide you in making the most beneficial choices.

Your Tax Rate Might Change Even if Your Income Doesn't


Even if you don’t anticipate a change to your income in the future, you could potentially find yourself paying higher taxes in 2026. 


The Tax Cuts and Jobs Act (TCJA) was signed into law by former President Trump in 2017.  The legislation reduced income taxes across the board for individuals and businesses, but most of these provisions are set to expire at the end of 2025 unless Congress acts to extend the provisions.  Will they extend the provisions?  It’s anyone’s guess.  The outcome will largely depend on the 2024 election, what party controls Congress, what Congress can agree on (if anything), and the state of the economy at that time.  As we approach the end of 2025, we will hopefully have more information, but the possibility of higher taxes starting in 2026 should be on everyone’s radar.  I’ll be writing more about this topic and related strategies in the future.   


Conclusion


Tax-gain harvesting is a strategic approach to tax planning that can help you minimize taxes on your investment gains.  Although tax-gain harvesting can be an effective tool for financial growth, it's just one piece of the puzzle and should not overshadow your overall investment strategy and financial goals. 


As always, the key to leveraging these strategies effectively lies in understanding your financial situation, so stay informed, make decisions based on your unique financial goals, and consult with a tax or investment advisor to ensure you are making the most of your investments given your tax situation.


Tad Jakes, CFP®, EA

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