_{Originally published 12/09/2022}

As we approach the end of the year, many investors will be considering tax-loss harvesting which is a common technique to take advantage of losses on capital assets. Another concept that should be considered is tax gain harvesting.

Tax Gain Harvesting

A lesser-known technique that certain taxpayers should keep in mind revolves around harvesting gains and filling up the 0% capital gains bucket. That’s right, if your total taxable income is within certain limits, you can pay $0 in tax on capital gains for the year.

As we can see above, there are 3 primary brackets that capital gains fall into based on taxable income. This is an important note, your capital gains are taxed based off your taxable income and not your adjusted gross income (AGI).

Since capital gains are taxed based on taxable income, a couple filing Married Filing Joint with adjusted gross income (AGI) of $109,250 will pay 0% on their capital gains after taking the 2022 Standard Deduction of $25,900 against their AGI.

In the example shown above, we have a couple that can receive $20,000 in capital gains for the year and pay 0% on those gains. This doesn’t reduce the couple’s total tax due for the year so why might we want to generate capital gains at 0% for the year?

Increased Basis!

The goal of a prudent taxpayer shouldn’t be to pay the least amount of tax in a given year, it should be to pay the least amount of tax over their entire lifetime to the IRS. In our example above, say the couple were to repurchase the exact same investment that they sold to generate the $20,000 of capital gains. They now have basis in the investment as of today; not their original basis that led to the gain. In other words, the couple was able to generate a free step-up in basis for their investment without generating any tax.

Above, we sell the original investment for a $20,000 gain and pay $0 in tax since our taxable income qualifies us for the 0% capital gain bracket. We then turn around and invest the proceeds back into the exact same investment but at today’s price. The “wash-sale” rule does not apply when selling securities at a gain! This in effect, raises the basis on the investment so in following years, we have a lower overall tax burden. (Higher basis equals lower gain)

Important Notes

Taxable Income includes Capital Gains

If you notice from the above examples, capital gains are included in calculating taxable income. In other words, the more capital gains you have, the higher your taxable income and smaller your window for paying 0% on those capital gains.

Capital Gains increase your AGI and MAGI

Generating capital gains will increase both your AGI & Modified AGI for the tax year. These are important landing points on the tax return as these figures are used in calculating other tax benefits such as deductions, credits and the taxability of specific income.

Pay Attention to State Taxes

Many states including Illinois will tax capital gains even if the gains aren’t taxed at the Federal level. It is important to consider how your state taxes capital gains and if this will have an impact on the benefits of tax harvesting your gains.

Capital Loss Carryovers

Harvesting capital gains in a tax year will reduce any capital loss carryovers you have from prior years. If you are considering a large liquidation of a capital asset (real estate etc.) in the coming years, it may make sense to hold onto those capital losses and use them in a future tax year.

Summary

Investors can utilize both losses and gains within their portfolios every year to minimize the amount of capital gains tax and ordinary income tax they pay over their lifetimes. Deciding on whether to harvest gains in your taxable accounts is an exercise that requires accurate calculations and in-depth analysis from a qualified financial planner or tax advisor. Bottom line: Tax gain harvesting has many benefits. Don’t let a 0% tax bracket go unused!