Financial advisors, blogs, and investment gurus have long espoused the virtues of tax-loss harvesting. Essentially, investors can sell off losing investments and use those losses to offset investment gains. And if those losses exceed any gains in a year, investors can carry them forward or use them to reduce ordinary income rates. The advent of ETFs and zero-cost commissions has pushed tax-loss harvesting into the forefront as investors can now sell a losing stock and then buy an ETF that tracks the same sector to stay invested. So, you can sell a losing position in 3M (MMM) and buy the Industrial Select Sector SPDR Fund (XLI) instead.
The thing about tax-loss harvesting is that it works well in the short term. Investors take advantage of short-term losses in their portfolios. But what about the long term? How can we be proactive with our long-term gains?
This is where tax-gains harvesting can come in.
Just like tax-loss harvesting involves selling your losers, tax-gain harvesting is about pruning long-term winners to help reduce taxes. That may seem like a misnomer; after all, taxes are paid on gains when sold. But investors can time their sales to reduce taxes and, in many cases, pay 0% on their gains.
The reason why tax-gain harvesting can work is that some investors can pay 0% long-term capital gains rate on their sales. Individuals who have taxable income of less than $40,000 or married couples with less than $80,000 in earnings fall into this category. While that may seem low at first, remember, this is after the standard deduction and contributions to retirement accounts. The reality is that there is some wiggle room with higher taxable incomes. The beauty is that investors can pay that 0% capital gains rate up to the $40,000 or $80,000 amounts.
This example from investment manager Charles Schwab highlights tax-gain harvesting in action.