“Why Would I Ever Want to Harvest a Capital Gain?”
Investors must be aware of the income tax implications of their trading activities. Most know that selling a financial security is a taxable event* and that doing so will usually create a realized capital gain (or loss). Brokers have long advised their clients to “harvest” capital losses as year end approaches since such a realized loss can be used to offset realized capital gains that may have been taken earlier in the tax year. The Internal Revenue Code even allows net realized capital losses (limited to $3,000 annually) to be used to offset ordinary income reported elsewhere on a client’s tax return. This loss harvesting strategy has been practiced for years and is well established in the investment/income tax toolbox. However, far fewer investors are cognizant that harvesting long term capital gains on investments (as opposed to losses) may also be a wise strategy for certain taxpayers.
The tax code does not treat all taxpayers identically as it applies to the taxation of long-term capital gains. While net long term capital gains result in either 15% or 20% taxation for most investors, lower bracket investors may enjoy a rate of 0%. For taxpayers filing as single with taxable incomes below $40,000 (tax year 2020), long term capital gains are assessed this 0% rate. Likewise, those selecting a married filing jointly status will escape long term capital gains taxation if their taxable income is under $80,000 (tax year 2020).
This differential in tax rates creates some planning opportunities. Suppose a married taxpayer has owned an investment for more than a year that has appreciated in value by $5,000. Further, assume this taxpaying household estimates that their taxable income for the current year will be $65,000. Since there is a $15,000 differential between $80,000 and their anticipated $65,000 taxable income, this household has “room” to harvest this long-term capital gain. As long as their taxable income remains under the $80,000 threshold, the 0% rate will be applied to any realized long term capital gain.
If this same couple desires to continue owning this investment, they can simply repurchase it shortly after executing the previous sale. In doing so, they will probably pay a price that is very close to what they sold it for and receive a “step-up” in cost basis on the same investment. This higher cost basis will prove beneficial if they sell this same investment at a future date because, depending on its sale price, it will result in either a reduced gain or a larger loss. Some astute investors have even been able to execute this strategy multiple times and benefit from serial “step-ups” on the same investment over time.
If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.
*This statement applies to taxable accounts only, and is irrelevant for IRA’s, Roth IRA’s, and employer sponsored retirement plans such as 401k’s.