Harvesting capital gains can be an important financial strategy during year-end tax planning. The tax-gain harvesting strategy applies to nonqualified (NQ) investment accounts versus a retirement account like a 401(k), IRA, or Roth IRA because income earned in a NQ account is subject to annual income tax.
Consideration should be given to harvesting gains to offset capital loss carryovers from prior years, as well as to maximize the 0% federal capital gain tax bracket.
Offset Capital Loss Carryover
In the tax year, realized capital losses from trading activity can be used to offset realized capital gains. Excess losses, up to $3,000, are available for deduction on the tax return. Losses in excess of $3,000 are ‘suspended’ or carried over to the following tax year to offset realized capital gains first, then income by up to $3,000. This carryover process continues until all losses have been utilized.
In instances where a taxpayer has significant capital loss carryover that would take years to recover if only applying the annual $3,000 income deduction, the taxpayer should identify appreciated securities that can be sold so the unrealized capital gain can be offset by the capital loss carryover. This is a tax efficient way to rebalance an account or liquidate positions to cash.
Capital Gains at 0% Tax
The federal income tax system has three tax brackets for capital gains, 0%, 15%, and 20%. In general, if you are in the 0%, 10%, or 12% federal tax bracket, you may qualify for the 0% long-term capital gain tax rate.
Taxpayers in lower income tax brackets should identify appreciated securities with unrealized capital gains that would fall into the 0% tax bracket. This is a tax efficient way to rebalance an account or liquidate positions to cash.
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 qualify for the 0% long-term capital gains tax rate or that you have enough capital losses to offset the realized gains.
Other Considerations
Realizing capital gains could impact other tax calculations that look at your Modified Adjusted Gross Income (MAGI), such as the taxation of Social Security benefits or the Premium Tax Credit.
Kiddie Tax rules may apply when reviewing accounts owned by dependent children.
Donating appreciated stock eliminates the taxable gain as well as provides a charitable deduction reported on Schedule A. Before selling a security, donation should be considered.