Graduate Level Optimizers: It’s Tax Gain Harvest Season

Tax Gain Harvesting… What In The World Is It & Why Would I Care?

This article has to do with taxable investment accounts and the tax on your gains from them. If your employment income is low enough and you have a sizable taxable account then tax gain harvesting is a great strategy to ensure you are not taxed on your investments if you follow the rules. So let’s talk first about tax brackets and then we can talk more about invested income taxing.

Let’s assume for your 2017 taxes you are married filing jointly. Let’s say you have an adjusted gross income of roughly $60,000 between you and your spouse. You will be in the 15% tax bracket when it comes to the money you have made on your W2 (bonus question: Do you know how much you will pay in taxes?) Here is a list of the 2017 tax brackets. Great news! In 2018 you would only be taxed at 12% due to the Tax Cuts and Jobs Act. This saves you $1,800 in taxes if you are in this bracket!

Tax Brackets for Married Filing Jointly W2 income

Tax Rate Taxable Income Bracket Tax Owed
10% $0 to $18,650 10% of taxable income
15% $18,650 to $75,900 $1,865 + 15% of the excess over $18,650
25% $75,900 to $153,100 $10,452.50 + 25% of the excess over $75,900
28% $153,100 to $233,350 $29,752.50 + 28% of the excess over $153,100
33% $233,350 to $416,700 $52,222.50 + 33% of the excess over $233,350
35% $416,700 to $470,700 $112,728 + 35% of the excess over $416,700
39.6% $470,700+ $131,628 + 39.6% of the excess over $470,700

What is interesting is that your taxable investment income is taxed differently. They are taxed through dividends and capital gains. A dividend is a portion of the profit of the company you hold. These are paid out while you hold your stocks and a capital gain or loss is the difference in the cost of the stock when you bought it versus when you sold it. If that is positive then you made a profit! Uncle Sam wants his share and you should know how he determines what’s his and what’s yours so you can work to keep more of yours. He rewards savers and taxes spenders. Do you want a wealth building strategy? Learn to save. Let’s see how Uncle Sam determines what’s his.

Short Term & Long Term Capital Gains

This is where the buy and hold strategy comes into play with your taxable accounts. When you sell a stock the tax you will pay on your capital gains depend on how long you have owned that particular stock. If you have held that stock for over one year, great, that means that you will be taxed at a lower rate tax rate. This is considered a long-term gain. If however, you sell that stock after only owning it for less than a year then you are subject to being taxed at your current marginal tax rate, ouch! This is a short-term gain.

Tax Brackets for Married Filing Jointly Investment Income

Tax

Rate

Taxable Income

Brackets

Short-term

capital gains

Long-term

capital gains

10% $0 to $18,650 10% 0%
15% $18,650 to $75,900 15% 0%
25% $75,900 to $153,100 25% 15%
28% $153,100 to $233,350 28% 15%
33% $233,350 to $416,700 33% 15%
35% $416,700 to $470,700 35% 15%
39.6% $470,700+ 39.6% 20%

Did you notice that 0% tax rate on long-term capital gains if you are in the 10-15% tax bracket (making $0 to $75,900 married filing jointly)? Yeah seriously, scroll back up and look at that. What this means is that you are able to have all the income from your taxable account not taxed!!! In order to complete this “tax gain harvest” you need to sell and buy back your investments. This raises your cost basis on the investment and as long as you are in those low-income tax brackets and the investments have been held for one year you do not pay takes on your gains. I will talk about what a cost basis is soon, so keep reading.

Tax Gain Harvest Now Is To Tax Loss Harvest Later

This strategy of tax gain harvesting sets you up to be in a good position for tax loss harvesting should the market drop as it does from time to time. Lots of folks know about the defensive move of tax loss harvesting, but not too many know about the offensive move of tax gain harvesting. Let’s walk through an example.

So let’s say you are that same person who is married filing jointly with $60,000 of AGI putting you in the 15% tax bracket in 2017. Let’s also say you decided at least over one year ago to invest in a taxable account. You placed $7,000 in that taxable account years ago and it has now grown to $18,000. No, no investment would do this for you in one year, but over years it would. So in our example, you have $11,000 of gains and subsequent taxable income. You would be taxed $1,650 if these were short-term gains since the tax rate there is 15%, but you have held onto them for longer than one year so your tax rate is 0% and you pay zero dollars in taxes!

If the market were to crash later in the year you then have room for tax loss harvesting. This has to do with cost basis. Cost basis is the original value of a stock the day you bought it. When you tax gain harvest you raise your cost basis by selling and then buying back the same stock tax-free.

Said In Another Way

  • So say in 2010 you had $7000 to invest and bought 100 stocks for $70 a share.
  • In 2017 that same 100 shares of stock that you bought in 2010 appreciated to $180 per share.
  • You sell and buy back that stock through tax gain harvesting and now your new cost basis is $180 per share.
  • If the market were to then crash in the following year (which it does do) you could tax loss harvest by selling off that stock and purchasing a different stock. There are laws that govern tax loss harvesting so know about the “wash sale” rule when you conduct tax loss harvesting.
  • Wash sale rules do not apply to tax gain harvesting.

In Summary

I know that was a lot of jargon. Hopefully, you tracked with some of it. I certainly had some trepidation about many of these subjects until I took the time to learn more about them. I find myself sometimes wishing I had a really good stockbroker buddy and a really good tax preparer buddy so I could bounce all these topics off of all of them at once, but I don’t. Now you know why I write these posts!

  • Your bonus question: okay so with an adjusted gross income of roughly $60,000 between you and your spouse do you know how much you will pay in taxes?
    • You are in the 15% tax bracket and you owe $1,865 plus 15% of the excess over $18,650.
    • 60,000 – 18,650 = 41,350
    • $1,865 plus .15*(41,350) = $ 8,067.50 of taxes!
    • It is no wonder that taxes are typically in the top three expenses found on an annual family budget. You don’t realize it because it comes right out of your check every time you get paid! What would you do if you could save an extra $8,000 per year? What are some ways you have learned to lower your taxes?

Thanks for the read 🙂