Tax Harvesting: The Way Out of Gains

Capital gains can be looked at as both a blessing and a curse.  The gain is a blessing because we all want our investments to perform well.  The curse can be the taxes one must pay, particularly for those in higher tax brackets.  A capital gain remains “unrealized” until an investment is sold, when the gain then becomes “realized”.  When gain is realized, it becomes taxable as either short-term or long-term capital gain, depending on whether the investment was held for under year, or if you’d owned it for a year or more.  Short-term capital gains are taxed at ordinary income tax rates, while long-term capital gains are a special category, with lower tax rates.

When one owns investments in a non-retirement account, the individual holdings each have their own cost basis.  Using stocks or bonds as an example, cost basis is generally the price that you paid for the securities, including purchases that were made by reinvestment of dividends and/or capital gains distributions, as well as transaction costs like broker commissions.  Sometimes, there can be a tremendous amount of gain.  I’ve talked with investors who have held on not because the investment was where they necessarily wanted their money at the time, but because they did not want to pay the capital gains taxes.

In instances where there is a lot of capital gain such as in one stock or fund, we create a plan that includes a capital gains “budget”, an actively managed account basing investment decisions on the current markets and economy and the individual’s risk tolerance.  For example, with a capital gains budget, we may only sell enough of the investment to realize $25,000 of gain that would be taxable in a given tax year.  With the proceeds, we base our investment decisions on what is happening currently rather than holding an investment that was a good buy years or even decades ago.  We can even lower the risk in the account by redeploying the money into more conservative investments or more tax-favored investments such as municipal bonds.  With a sound financial plan and tax harvesting, we can methodically work our way out of gains.

LouAnn Schulfer of Schulfer & Associates, LLC Wealth Management can be reached at (715) 343-9600 or louann.schulfer@lpl.com.  www.SchulferAndAssociates.com

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor.  Member FINRA/SIPC.