2017 has been a great year for the stock market. Despite uncertainty around tax reform, verbal skirmishes with North Korea, and an aging bull market, the market continues its quiet and steady march forward. The S&P 500 Index was up each of the first three quarters, and as of 11/14/17 has returned 15.19% for the year .
These stellar market returns present an opportunity to save on taxes in future years through tax-gain harvesting.
What is tax-gain harvesting?
Many have heard of tax-loss harvesting. Tax-loss harvesting allows investors to lower their tax bill by selling positions that have dipped since being purchased. Essentially, investors are booking, or realizing, a tax loss to offset other capital gains or, if they have more losses than gains, up to $3,000 of ordinary income. To qualify, investors must wait 30 days to repurchase the position they sold at a loss. This restriction is called the wash-sale rule.
Unlike tax-loss harvesting, which takes advantage of losses to lower your gains and shave down your tax bill, tax-gain harvesting actually increases your capital gains. In this strategy, investors sell an appreciated position to realize a tax gain. Unlike tax-loss selling, you can purchase the same position back right away, as the wash-sale rule doesn’t apply.
Why would anyone harvest tax gains?
At first, tax-gain harvesting sounds pretty non-intuitive. After all, most of us are trying to limit our yearly checks to the IRS. Why intentionally book more capital gains? The reason is you could save on taxes in future years.
This strategy works best for investors in the lower federal tax brackets. For 2017, single filers making up to $37,950 and married couples up to $75,900 pay no taxes on long-term gains . For individuals below these limits, tax-gain harvesting is a nearly “free” way to increase their cost basis. And why up your cost basis? Increasing the cost basis “shields” part of the gain from taxes down the road.
And don’t worry, we haven’t forgotten about our high-earner friends. Investors in higher brackets may still consider tax gain harvesting. Those in a lower-than-usual bracket for 2017 may wish to harvest some gains, up to the next capital gain bracket, to “shield” more of the gain from taxes in future years.
Who benefits from tax-gain harvesting?
This non-intuitive strategy is ideal for those in lower tax brackets who pay 0% on long-term capital gains. By harvesting their gains now, these investors are giving themselves a federal tax-free way to save on future possible taxes.
This strategy also benefits those whose tax brackets will go up soon. For example, an entrepreneur in a recent start-up or a high earner between jobs may wish to “book” some capital gains in 2017, while their income is relatively low, before their income increases in future years. This strategy could also work for individuals with tax write-offs and deductions (such as depreciation on a major business asset or alimony payments) that will taper off or go away in upcoming years. Such investors can take advantage of their lower income by realizing some of their capital gains now.
What else should I know?
Tax-gain harvesting may not be completely cost-free, even for those in the 0% capital gain bracket. Investors may still incur additional state income taxes. In California, for example, a married couple can earn up to $75,900 and face no capital gain taxes  and yet still pay up to an 8% marginal tax rate in state taxes .
Additionally, investors may miss out on the qualified status of dividends. Dividends on stocks or other positions only receive the preferred “qualified” treatment once they’ve been held for a certain length of time, usually 60 days. This holding period is reset after selling the position to harvest tax gains.
Another key consideration is how the increased income will impact your entire tax situation. Since the additional gains increase your AGI (Adjusted Gross Income), your tax deductions and tax credits may be impacted or even phased out. Likewise, those on Social Security may find their benefits indirectly taxed, since a higher AGI may cause them to be included in total income .
Stratos Wealth Advisors and its affiliates do not provide tax, legal or accounting advice. 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.