Tax Gain Harvesting Explained: A Strategy For Managing Capital Gains Taxes

Most investors focus on how to avoid capital gains taxes - but far fewer think about when it actually makes sense to realize them.

In certain low-income years, intentionally selling investments at a gain can reduce future tax bills and lock in long-term tax savings. This strategy, known as tax gain harvesting, is often overlooked but can be especially powerful in the years leading up to or just after retirement.

Executive Summary

• Unlike tax loss harvesting, which realizes losses to offset gains, ordinary income, or carry forward unused losses, tax gain harvesting is used to help reduce or eliminate tax bills on unrealized gains.

• Tax gain harvesting aims to fill up your long-term capital gains bucket when income is low, allowing you to benefit from the 0% long-term gain bracket.

What Is Tax Gain Harvesting?

At a basic level, gain harvesting is when you deliberately sell an investment at a gain to realize that gain now and pay a lower tax than you would in the future. This strategy fills certain long-term capital gains brackets, locking in tax savings when income is ideally low - usually in the years right after retirement.

How Capital Gains & Losses Work

As mentioned in our previous article about tax loss harvesting, any time you sell an investment, it creates tax implications.

Whether the sale is taxable depends on whether it is sold at a gain or a loss:

• Selling at a gain occurs when you sell the asset for more than its cost basis.

• Selling at a loss occurs when you sell below the cost basis.

Gains and losses net against each other:

• Example: Realized gain of $50,000 and a realized loss of $25,000 = net gain of $25,000.

• Conversely: Realized loss of $50,000 and a realized gain of $25,000 = net loss of $25,000.

Short-Term Vs. Long-Term Capital Gains

Currently your gains can be categorized and taxed as either long-term or short term:

• Short-term capital gains are taxed at ordinary income tax rates.

• Long-term capital gains are taxed at typically lower rates.

  
  

Whether gains are taxed at short-term or long-term rates depends on how long you held the investment:

• Less than a year = short-term rates.

• More than a year = long-term rates (generally more favorable).

Using the 0% Long-Term Capital Gains Bracket

Since we operate in a progressive tax system, higher income is taxed at higher rates. For example, someone recently retired who hasn’t yet filed for Social Security or pension income could benefit by selling a portion of long-term unrealized gains while income is low, taking advantage of the 0% long-term gains threshold.

Wash Sale Rules & Resetting Your Cost Basis

Wash sale rules, can disallow losses if you turn around and rebuy a substantially identical security within 30 days before or after the sale. When you gain a harvest, you can immediately turn around and repurchase that identical security without incurring the wash sale rule.

This, in essence, resets your cost basis, thus reducing your future potential gains. This is especially useful if the position you own is something you want to have in the long-term. You can keep that same position by doing so.

Who Tax Gain Harvesting Is Most Useful For

When it comes to tax loss harvesting we are essentially using the losers to offset the winners and reduce our tax bill in some manner, with tax gain harvesting we are not looking to offset our losses but instead take advantage of favorable long-term tax rates by realizing gains now if our tax rates may be higher in the future.

This is usually the most beneficial for those who have substantial capital gains in their brokerage account and have lower incomes which can happen from a recent job change, a lower year in business revenue, or the years right after retirement when you haven’t yet filed social security, or started drawing your pensions.

Caveats & Helpful Tips

Be mindful that your gains are added onto your tax return as income, the amount of income you have each year can affect other types of taxes and can make portions of your social security taxable, or can cause additional medicare premiums due to IRMAA, and can even reduce or eliminate any healthcare subsidies since these are all based on certain income thresholds.

Conclusion:

Tax gain harvesting is not about creating unnecessary taxes - it’s about being intentional with when gains are realized. In the right circumstances, particularly during low-income years, this strategy can help reduce future tax exposure and improve long-term tax efficiency.

Like most tax planning strategies, its should be considered a tool not a rule and the value depends on timing, income levels, and coordination with the rest of your financial plan and team of professionals. Overall it’s important to evaluate it within the broader context of your overall financial situation.

Key Takeaways

• Tax gain harvesting fills long-term capital gains brackets when income is low.

• It helps pay less tax now than you would in the future.

• Gains can be realized without impacting wash sale rules.

• Most useful for individuals with low current income and significant unrealized gains.

• Be mindful of how additional income can affect Social Security, Medicare, and healthcare subsidies.