Understanding tax-loss and tax-gains harvesting

As the year comes to a close, you might be busy planning for the holiday season. But there’s another planning activity that could also be on your to-do list: planning your capital gains. Now might be a good time to review your capital gains and discuss with your financial advisor and tax professional which tax-smart strategies might be available to you. Trading at an opportune time within your taxable accounts can have a meaningful impact on your capital gains taxes and increase your after-tax investment returns.
When you sell or redeem an investment, this can result in a capital gain or loss. Simply put, the gain or loss is the difference between the proceeds from the sale and the cost basis (the total original purchase price of a security including commissions, fees and reinvestments). If you have capital gains during the year, you might have to pay taxes on them.
Capital gains and losses are only relevant for taxable investment accounts (such as a brokerage account). Tax-advantaged accounts, such IRAs, 401(k)s or 529 plans, are not subject to capital gains tax. If taxes apply, withdrawals from these accounts are taxed as ordinary income.
Every time you sell investments in a taxable account, the resulting capital gain or loss is classified into short or long term depending on how long you held the investment.
To determine how much tax you owe on your capital gains:
This could result in the following scenarios:
Tax consequence | |
---|---|
Net short-term gain > net long-term loss | Short-term gain taxed as ordinary income |
Net long-term gain > net short-term loss | Long-term gain taxed at capital gains rate |
Net short-term loss > net long-term gain | Up to $3,000 ($1,500 if married filing separately) can be used to offset other income. Any excess can be carried forward to next year as a short-term loss and used to offset future capital gains. |
Net long-term loss > net short-term gain | Up to $3,000 ($1,500 if married filing separately) can be used to offset other income. Any excess can be carried forward to next year as a long-term loss and used to offset future capital gains. |
Tax-loss harvesting is a strategy where you sell securities at a loss to offset capital gains. For example, if you sell an investment with a $10,000 taxable gain, you may be able to sell another investment at a $10,000 loss to fully offset it.
Note that tax-loss harvesting is subject to a limitation known as the wash-sale rule. The wash-sale rule prevents you from recognizing a loss if you or your spouse buy a “substantially identical” security within 30 days before or after the sale (the loss is not permanently gone but is deferred until the new securities are sold). Because of this rule, you should consider how tax-loss harvesting will affect your investment strategy. In particular, good candidates for tax-loss harvesting are investments that no longer fit your strategy (for example, when rebalancing your portfolio), have poor investment prospects or can be easily substituted with other investments (for example, with an ETF in the same sector or industry).
There may also be times when it makes sense to harvest your gains instead.
If your taxable income is below a certain threshold, your long-term capital gains will be taxed at 0% up until your taxable income exceeds that threshold. In 2022, this threshold is $41,675 for single filers and $83,350 for married couples filing jointly. For example, let’s say that you and your spouse file jointly and earn $100,000 in 2022. After taking the standard deduction of $25,900, your taxable income is $74,100. The maximum amount of capital gains that can be taxed at the 0% rate is $83,350, which means you can realize $9,250 in gains without paying any federal income taxes.
If you purchase shares of a security at different prices over time, your cost basis will be different for your different shares. Therefore, you’ll need to be aware which shares are being sold to determine your capital gains.
There are different methods you can use to specify which shares are to be sold, including:
Choosing a cost basis method can be challenging and can have different tax consequences, so you’ll want to consult with your tax professional to be certain that you’re making the appropriate choice for your situation.
Overall, it is important to consider how selling securities impacts your capital gains and the resulting taxes. By working with your tax professional and financial advisor, you can potentially lower your taxes and have additional dollars to put toward your financial goals.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation. This content should not be depended upon for other than broadly informational purposes. Specific questions should be referred to a qualified tax professional.
1 Edward Jones uses FIFO as default for Advisory UMA and Select accounts, but a client can choose an alternative method. Advisory Fund and Guided Solutions accounts use a tax-aware methodology, which is an automated feature applied to all sell trades with the intent of minimizing the income tax impact.