Tax Loss Harvesting and Tax Gain Harvesting

As the year approaches the end, I wanted to talk about 2 trading strategies that can help with taxes.

The first is tax loss harvesting, where you have a loss on a position in your portfolio.  The second is tax gain harvesting, where you fall into a low income tax bracket and can sell stock at a gain and repurchase the stock without paying taxes.

Tax Loss Harvesting

The IRS allows for someone who has a loss in a stock position (or mutual fund and ETF) to realize that loss by selling the position and in turn use the loss to offset gains in another position.  If you have no realized gains in another position, you can use up to $3000 in losses against your ordinary income.  Losses over $3000 can be carried forward to another tax year.

In a nutshell, what that paragraph means: You have $10,000 in realized long term capital losses in GE stock.  You have $10,000 in long term realized gains on MSFT stock.  Using the losses to offset the gains, you owe $0 in taxes.

In the above example, let’s say you didn’t realize a loss in GE for the year, but did have the long term capital gains on MSFT of $10,000. For most people this means, you will owe $1500 in long term capital gains at the 15% capital gains rate.

Let’s make one more example.  Let’s say you had $15,000 in realized long term capital losses on GE stock.  Still have the same $10,000 in long term realized capital gains on MSFT stock.  $10,000 of the losses can be used to offset the $10,000 in gains.  Also, $3000 can be used against your ordinary income.  The remaining $2000 in losses can be used in the next tax year.

Something to be aware of in tax loss harvesting is called the “wash sale rule”.  A wash sale prevents you from using the loss on your taxes.  A wash sale occurs when you sell a stock at a loss and try to buy the stock back within 30 days.  For example, you own 100 shares of GE at $35 and sell on December 1st at $32 for a $300 loss.  If you buy GE stock back within 30 days, say December 10th, at $32 the $300 loss is disallowed.  As you can see, this would give a trader a tax benefit, while creating no real change in the traders position.  The IRS does not allow for these “free” tax benefits.  Also, the IRS in the last decade has learned about options.  You would not be able to sell GE stock at a loss and purchase GE call options inside of the 30 days.  The net position is the same- long GE, so you would fall in the wash sale rule.  You could however, sell GE stock at a loss and purchase another large industrial company like MMM as a work around the wash sale rule.  That would be seen as different enough.  The worst thing that can possibly happen within that 30 day time frame is the stock you sold goes on a run, something to consider.

Tax loss harvesting can be a nice way to save on taxes by using losses against your gains or even ordinary income.  Just be aware of wash sales.

Tax Gain Harvesting

For people who fall in the 10-15% federal income tax bracket, you can do something called Tax Gain Harvesting.  Tax Gain Harvesting allows you to sell your stock at a gain, pay zero taxes, and subsequently repurchase the stock.

This is for people in the 10-15% tax bracket, because under current tax laws people who fall in these tax brackets pay 0% long term capital gains.  The reason you would be interested in tax gain harvesting is the tax free adjustment (upwards) or your cost basis.

This is the case for me this year.

Let’s use an example to explain.  Let’s say you bought GE stock back in 2008-2009 at $7 per share.  Today the stock trades at roughly $32.  You sell the stock at $32, and turn around and repurchase the stock at $32.  This would be a long term capital gain of $25 per share.  Normally, you would pay 15% in long term capital gains tax on that $25 gain.  However, for someone in the 10% or 15% tax bracket, you pay $0 in capital gains tax.  What you have in effect done, is adjust upwards your cost basis from $7 to $32 without paying taxes.  Thank you Uncle Sam.  You might be interested in this, if, say your income is low one year and will go up the next.  By adjusting your cost basis upwards with tax gain harvesting, you could also realize a loss in a given year when a down market occurs (say 2008, just be aware of the wash sale rule).

The 2 main things on tax gain harvesting is making sure you fall in the 10% or 15% tax bracket, and the position you are wanting to use for tax gain harvesting is at a long term capital gain (short term gains are taxed at your ordinary rate).

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