Understanding How Tax Gain Harvesting Works

The concept of "tax-loss harvesting," which allows you to collect your losses when an investment loses money, is familiar to most investors. But did you realize that you can also get the benefits? Tax gain harvesting, when done correctly, can save you money, lower your taxes, and reduce the risk in your portfolio.

Let's have a look at how capital gains harvesting works.

What Is Tax Gain Harvesting, and How Does It Work?

Tax gain harvesting is the practice of strategically selling assets that have been appreciated to reduce taxes and restore portfolio balance. The conventional idea is to avoid paying capital gains taxes by deferring the sale of valuable assets. This isn't always the ideal strategy because it might lead to portfolio over-concentration, which increases the chance of future losses.

How Does Tax Gain Harvesting Work?

You should sell appreciated assets for a variety of reasons. Here are three instances in which it makes sense to sell and harvest your gains to improve the overall financial health of your portfolio.

This year, you'll be in a lower tax bracket. Locking in your earnings during bad years is a good strategy for folks whose income swings from year to year. To keep your tax burden low, you can take advantage of lower tax brackets. In addition, if your taxable income is less than \$40,400 as a single taxpayer (\$80,800 married filing jointly) in 2021, your capital gains tax rate could be as low as 0%.

Balance out your portfolio's losses. You can counterbalance the gains you're harvesting dollar-for-dollar if you have losses in your portfolio. Many investors are aware of this tax loss harvesting technique. You can harvest your losses at any time during the year, but most investors wait until the end of the year to reap the benefits of their losses and tax status.

Reduce the number of focused places (AKA rebalancing your portfolio). For their portfolios, most investors have a good mix of stocks and bonds. Your portfolio mix may need to be rebalanced based on market performance. To re-establish the right balance, rebalancing entails selling appreciated assets and purchasing those that have lost money. This prevents you from becoming overly invested in a single asset class and allows you to purchase assets that are "on sale" at a discount to their normal value.

Bottom Line

For many investors, tax gain harvesting is the best way to reduce future tax costs and rebalance their portfolios. Because you'll have a better view of your possible tax burden at the end of the year, this method is usually implemented then. Working with your financial advisor and tax specialist to understand how tax gain harvesting may affect your overall goals is recommended before making any decisions.