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With recent market volatility, there’s a lot of talk about loss harvesting for tax purposes. Now, despite the recent dip, markets are still near all-time highs, so it’s actually possible that the less discussed technique of gain harvesting could be more relevant. What is gain harvesting?
Well, first, none of this applies to tax advantaged accounts like IRAs, 401(k)s or 529 college savings plans, just taxable accounts. Gain harvesting is the practice of selling a holding for a gain, triggering a taxable event, and immediately buying the holding back.
So you may wonder why would anyone want to buy back something that they just dumped and incur gains before necessary? While the answer is taxes. Done correctly, the result of gain harvesting can be low, even no taxes on the gains now, and lower taxation on future gains. Strategically, it’s similar to executing a Roth conversion in that you’re paying some tax now to avoid paying more taxes later.
We consider gain harvesting when a client is temporarily in a low tax bracket. Common examples would include people between jobs, kids with assets of their own, or in certain types of accounts like custodial accounts and retirees before required minimum distributions or pensions kick in.
We have examples of exactly how gain harvesting works, information on how it can conflict with a Roth conversion plan, and information on how we help clients evaluate the technique in the post on our website titled “What Is Gain Harvesting?” As always, if you have questions, please contact us. We’d love to hear from you.
What is gain harvesting?
“Gain harvesting” refers to the practice of selling a holding for a gain in a taxable account, triggering a taxable event, and immediately buying the holding back. The strategy does not apply to retirement accounts, tax-deferred accounts, or any type of IRA.
Say you own a holding worth $25,000 that you bought for $20,000. A gain harvest would occur by selling the holding and immediately buying it back for $25,000. This results in a $5,000 gain to be added to Schedule D of your Form 1040.
Why would anyone want to incur gains before they are necessary? The answer lies in tax rates. If you have owned a holding for more than twelve months when it is sold, the gain is deemed long-term. The rate applied to long-term capital gains is lower than the rate applied to ordinary income. Ordinary income includes items like wages, interest, non-qualified dividends, and retirement account distributions.
Tommy Lucas, CFP®, EA explains, “In fact, if you are married and filing a joint return, to the extent your taxable income is below $94,050 in 2024 ($47,025 for single filers), the tax rate on long-term capital gains is zero. From $94,051-$583,750 ($47,026 -$518,900 for singles) the long-term capital gain rate is 15% while ordinary income is taxed at anywhere from 22%-35%. For taxable incomes higher than those levels, the capital gain rate is 20% versus 35%-37% on ordinary income. Even if, due to high income, a household is subject to the Net Investment Income Tax of an additional 3.8%, every dollar of long-term capital gain is still taxed at a lower rate than ordinary income.”
In addition, because you bought back the holding at $25,000 in our example, future gains or losses would be calculated based on that higher new purchase price of $25,000, not the original $20,000. This can yield a lower future tax bill whenever the holding is sold.
Therefore, it is possible that the result of gain harvesting can be low or even no taxes on gains now, and lower future taxation on subsequent gains.
Therefore, it is possible that the result of gain harvesting can be low or even no taxes on gains now AND lower future taxation on subsequent gains.
Strategically, gain harvesting is similar to other income acceleration strategies, like a Roth conversion. You may pay some tax now to avoid more taxes later. As such, we consider gain harvesting when a client is temporarily in a low tax bracket, such as when in between jobs. This strategy can also be utilized for children with assets of their own or in certain types of accounts, such as custodial accounts.
Gain harvesting can sometimes make sense for retirees before Required Minimum Distributions (RMDs) begin because clients can be in a lower tax bracket today than they will be when RMDs begin. However, that is also when Roth conversions become attractive. How do you decide which is most advantageous? We run what is essentially a mock tax return to project various scenarios and compare the results to our client’s goals and priorities.
Fall is tax projection season, so we will soon be analyzing these and other year-end moves to benefit our clients.