Don't Mess With Taxes

Yes, cash sometimes is called lettuce, but tax gain harvesting isn't just about more green for your wallet. It could help reduce taxes you sell on assets you sell in the future.

Even if you're not among the wealthiest, if you have invested a bit, you probably keep an eye on the markets. And you probably took a long look yesterday, when the Dow topped 36,000 for the first time ever.

Hey, I'm right there with you. I checked my holdings to see how much they were up at that point. We all like positive reinforcement.

If you're investing for the long haul, which is a good idea, and still have some time for your assets to grow, then just enjoy the bump your portfolio got.

But if you've been considering selling a holding or two, now might be a good time to act. It's a win-win if your long-term asset value is up and you're in a relatively low tax bracket. The profit will be taxed at capital gains rates likely lower than your ordinary income rate. Some might not owe any taxes all.

And if you go all in on tax gain harvesting, the market moves you make now could pay off again at a future tax time.

Harvesting portfolio losses: If you read my November tax moves post from earlier this week (thanks!), you know that the end of the tax year is a good time to evaluate your investments.

In most cases, folks are looking at their assets to cull those that haven't done so well. By selling losers, a process popularly referred to as tax loss harvesting, you can offset any capital gains you've had in the tax year.

If you have more losses than gains, you can use up to $3,000 of those excess bad investments to offset your ordinary income.

Reaping investment cash and tax win: If, however, you have a lot of winners, you also might want to consider tax gain harvesting, too.

As its name suggests, you harvest capital gains when you sell stocks that have appreciated nicely. When they are assets you've owned for at least 366 days, i.e., more than a year, they then are characterized by the Internal Revenue Service as long-term capital gains, which generally are taxed at more favorable rates.

In fact, taxpayers in the 10 percent and 15 percent tax brackets owe no capital gains taxes on such sales. Most of though, will likely owe 15 percent tax on at least some of our long-term capital gains. And wealthier taxpayers will owe a 20 percent tax on long-term gains plus, depending on just how rich they are, additional taxes on their investment income.

The capital gains tax rates stay the same each year — for now; Congress is considering making changes that could affect billionaires — but the income brackets for each rate are adjusted annually for inflation.

So you ask, if I don't have an immediate need for the money, why in heaven's name would I want to sell and pay taxes, even at rates lower than ordinary tax rates, on the profit? Isn't the conventional tax wisdom to delay tax payments for as long as possible?

Good questions. Here, for some folks, is a good answer. You want to reset your cost basis.

Reset basis lowers future profit, tax due: The value of any asset is what is known in the tax and investing worlds as its cost basis, or simply basis.

Basis begins with the price you paid for the asset. Certain actions and transactions can increase an asset's basis. When you eventually sell that asset, its basis is used to calculate the profit you make. And it's the profit on which you pay tax.

To find your taxable profit, you subtract the asset's basis from its sales price. The larger your profit, the larger your potential tax bill.

So you want to reduce your profit, at least when it comes to tax computations, in order to lower your tax bill.

A larger basis amount will do that.

And tax harvesting can help you reset your basis so that as the stock's value continues to appreciate, you'll have a larger basis to use in calculating your profit.

Sell then rebuy: In tax gain harvesting, you sell the stock and then use the money to repurchase shares of the asset. By doing so, you still have the same amount invested as you did originally in the stock, but now the share price, a major part of your basis calculation, is at a higher level.

That increased value will be used when you sell the stock again more than a year later to determine your capital gains tax then.

This very simple, for-illustration-purposes-only example explains:

• You bought 100 shares or XYX Corp. two years ago at $50 a share, giving you a basis of $5,000. You sell the shares at today's price of $75 apiece, or $7,500. That gives you a profit of $2,500 on which you owe no capital gains tax because you're in the 15 percent ordinary income tax bracket.
• You use your $7,500 to rebuy 100 shares of XYX Corp. at $75 a share. This resets your basis in the stock at $7,500.
• In five years, you sell your 100 XYX shares that by then are worth $125 apiece. That gives you $12,500.

Using your reset basis, you owe capital gains on $5,000 ($12,500 minus $7,500). You now are in the 25 percent tax bracket, meaning your capital gains tax rate is 15 percent, producing a tax bill on your profit of $750.

If, however, you had simply held the original $50 apiece XYX shares, your taxable profit on your final sale would have been $2,500 more or $7,500 ($12,500 minus $5,000). And your 15 percent capital gains tax bill would have been $1,125.

Of course, with stocks things could go the other way, meaning you'll have a larger loss to harvest. As noted, that could be good if you need tax losses at filing time.

But for today's purposes, we're going to be upbeat and go on the assumption that you picked a sure-fire investment winner. (If that is indeed true, let's talk!)

No wash worries: Ah, I hear some chatter out there from my investing readers. You're worrying about the wash sales rule.

I have two things to say. First, thanks for paying attention to my earlier posts (and tweets and book) on this topic, and second, stop worrying.

The wash sale rule, which says you cannot take tax advantage of a losing asset and then repurchase substantially the same stock, only applies to losses. Basically, the IRS doesn't allow you to sell a dog of stock solely to get a tax break.

However, when you sell a stock that's gained in value and on which you pay tax (or don't have to pay based on your adjusted gross income), then the IRS is fine with you rebuying not only a substantially similar stock, but the actual stock itself. The tax man is getting his cut on your sale profit, so what you subsequently do with your portfolio is fine with him.

Heck, Uncle Sam is glad you're buying back a winning stock since he's likely to get more of your money from it later!

Who should, and shouldn't, harvest tax gains? For someone whose income tops out at the 15 percent tax bracket, tax gain harvesting is a no-brainer.

You'll owe no capital gains tax now and by resetting your asset's basis, it could help reduce your possible capital gains tax when you sell the repurchased shares later and are in a higher tax bracket.

Just make sure that the income from the asset sale doesn't push you into a higher tax bracket. That could cut into any tax advantage the sale now offers.

If that's your financial situation, they you'll need to do some calculating, investment prognosticating, and soul searching.

Do you have the money, beyond the sales assets, to pay the taxes? Do you believe the holding will continue to grow in value? Are you comfortable making the move?

Note, too, that tax gain harvesting works only with taxable accounts. So if all your holdings are in, for example, tax-advantaged accounts retirement accounts, sorry.

And again, any transaction must involve long-term assets, those held more than 365 days.

All these variables mean that tax gain harvesting might not be the best choice for you, either financially or emotionally. But at least look into it and discuss it with your tax and financial adviser(s).

You also might find these items of interest:

• Place your eggs, er, money into different tax baskets
• Contribute to your 401(k) & claim the Saver's Tax Credit
• IRS clarifies when a cryptocurrency transaction isn't a tax transaction

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