Tax Savings Strategies For Your Portfolio: Tax Gain Harvesting

The current state of the economy along with COVID-19 has brought a lot of change to people’s financial lives. Whenever there is change, good or bad, involving money it can be a good time to sit down to review your finances. This includes reviewing your income, taxes, and investment portfolio.

In this article, I am going to discuss the concept of tax gain harvesting. Harvesting gains can be a powerful strategy to help you save money in taxes by strategically trading your portfolio. You can see my previous blog post on capital gains tax by clicking here. You can see my previous post on tax loss harvesting by clicking here.

Definition of Tax Gain Harvesting

I will reiterate from my previous post the basic concept of harvesting losses and gains. Tax loss harvesting and tax gain harvesting occur when you sell an investment and buy a different one in its place. You are harvesting the losses or gains by intentionally selling the position and buying a different position thereby keeping the money invested. The goal is to take the tax hit now, or capture the loss, allowing you to take advantage of either lower capital gains or income tax rates depending on your situation.

Benefits of Tax Gain Harvesting

The benefit of tax gain harvesting is to lock in your current tax rate. This can be beneficial if you have a year where you expect your income to be significantly less than usual. Some common scenarios would be a job loss or transition, going back to school, or starting a business. These scenarios can result in less taxable income for the household.

If you are in a lower tax bracket it can be beneficial to review your portfolio. If you have investments with large gains in a taxable account you can sell them to realize the gains at a lower tax rate. Your tax rate could be at 0%, 15%, or 20% for long term capital gains depending on your income. You are also resetting the cost basis at a higher amount and locking in the current tax rate by selling the position.

If you are single and your taxable income is below $40,000, or $80,000 if you’re married, then your long term capital gains rate is 0%. This means you can sell out of positions at a gain, and if you keep your taxable income below these amounts post sale, you will be taxed at 0%. See the 2020 long term capital gains tax rates below.

Another way to think about this is that your taxable account essentially acts as a Roth IRA. You could avoid paying taxes on some of the gains inside the account. It may make sense to go ahead and sell out of positions that may have larger gains to reset your cost basis and generate some tax savings.

Below is a table showing the differences between two tax scenarios and selling the same investment. The filing status in this example is married filing jointly and based on the 2020 tax rates.

The concept is that you avoid paying tax on the gains or pay at a lower rate due to the change in your income. If you would have otherwise waited until and your income or tax rates increased you could end up paying more in taxes. This is why you need to be opportunistic with your investments should there be a change in your tax situation.

Tax Gain Harvesting Strategies

As mentioned above, different circumstances can impact your tax situation which will dictate your decision making around managing your portfolio. Being mindful of your taxable income for the year, deductions available, and understanding the individual investments in your portfolio will be needed to determine if it makes sense to harvest gains.

Here are some scenarios and strategies to consider when looking at your financial situation:

Lower marginal income tax bracket:

If your income has decreased for the year, review the current tax tables. Analyze your tax situation and project which tax bracket you expect to be in for the year. This will help you determine your tax rates for ordinary income and capital gains tax.

If you are harvesting long term capital gains you will be subject to 0%, 15%, and 20% preferential tax rates. If for any reason you are in a lower bracket for the year, it could make sense to go ahead and harvest gains with the goal of paying less in taxes than you would have otherwise.

Fill up your current tax bracket:

A lot of people’s tax situation stays fairly consistent over time especially if they have a stable income or have been with the same company for extended periods of time. This makes tax planning more predictable.

Under this scenario, you may want to fill up your current tax bracket by harvesting some gains, especially if you think you will be in a higher bracket in the future.

Legacy investment considerations:

If you are in a situation where you want to harvest gains you should consider selling out of old stocks or legacy investments that you want to sell. The benefits could be harvesting gains strategically to save on taxes and diversifying your portfolio in the case of selling individual stocks or old employer stock.

Changes in the tax code:

If you expect there to be changes in the tax code that will negatively impact your tax situation, it could make sense to harvest gains. A good example would be the sunset provision on the 2018 TCJA. These rates are set to go back to where they were before 2018 potentially putting some people in a higher bracket.

Is Tax Gain Harvesting Worth It?

I believe tax gain harvesting can help you save money in taxes. The hard part is knowing what your tax rate will be in the future or finding the appropriate scenario for comparison purposes to understand if you really have made a difference.

I would recommend reviewing your portfolio throughout the year to see if you can strategically rebalance or harvest gains. This will depend on your situation as well as what the market is doing. Some people only harvest gains at year end but I would encourage this to be done periodically.

Software through your custodian can assist you in rebalancing your portfolio to help you understand the tax implications of selling your investments. Some custodians such as Betterment, Wealthfront, or TD-Ameritrade will have the appropriate tools to analyze your portfolio. As always, feel free to reach out with any questions about your situation. I offer a no-cost portfolio review and consultations.

If you’d like an objective second opinion about your finances, please contact Michael Shea, a CERTIFIED FINANCIAL PLANNER? at Applied Capital. Email him at [email protected] or fill out a contact form.

DISCLAIMER

This blog is provided for informational purposes only. Such views are subject to change at any point without notice. The information in the blog should not be considered investment or tax advice or a recommendation to buy or sell any types of securities. Some of our blogs or information therein have been obtained from third party sources believed to be reliable but such information is not guaranteed. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. No reliance should be placed on, and no guarantee should be assumed from, any such statements or forecasts when making any investment decision.