Year-end Topics: Harvesting Gains

Well, it’s suddenly December again. I don’t know about you but this year the Holidays sure are coming up fast. There’s a feeling of year-end inertia that settles in right about now, mostly because so much of what I do as a financial planner is based on the tax year, which for most folks ends on December 31^st.

As such, here’s a topic I think about all year but that takes special significance as we approach year-end.

Harvesting gains and losses – This has been a good year so far for stocks and bonds, even with all the trade-related headlines. The major US indexes are up 20+% and many bond funds are up high single digits, and some are up more than that. The reasons for these returns, and future expectations, are beyond the scope of this post, but the gains are good, nonetheless.

If you have large expenses coming up or just need money to help fund your retirement spending, it’s a good idea to consider rebalancing your portfolio and turning some of these paper profits into cash.

A quick definition: In the tax jargon, you “realize” a gain or loss when you sell an investment. This is taxable when done in your brokerage account. Until you sell an investment, the gain or loss is “unrealized” and not taxable.

You can realize gains anytime in your retirement accounts (IRAs, 401(k)s, etc) without much regard to taxation, so those are great for rebalancing your portfolio. The government gives you a pass on taxes in those accounts so long as the money stays inside of them (they’re known as being tax-deferred). But getting at that money to spend is more expensive because retirement distributions are typically taxed as ordinary income.

Compare that to a regular brokerage account where anything that happens within is fully taxable. Dividends are taxed in the year received, and so are gains when investments are sold. But this can work to your advantage because most investors get preferential treatment (lower rates) when paying taxes on realized gains on investments held over one year. If held for less time, the gain is considered “short-term” and subject to ordinary income taxes. This makes it beneficial to take profits in your brokerage account and not your IRA, for example, when getting cash to spend since, again, money withdrawn from your IRA gets no special treatment = higher taxes.

As we approach year-end and you think about your income situation this tax year, look at upcoming needs for cash and decide if realizing gains is appropriate. You can also spread your gain over multiple tax years.

For example, say you need to access $20,000 in the next few months. What’s to stop you from selling some of your investment this year and then selling the rest in January? Doing so spreads out your tax liability over two years. Maybe this helps you stay within your current marginal tax bracket or, at loftier income levels, keeps you from paying higher Medicare premiums. It’s a simple process that helps keep more money in your pocket (or your portfolio) over time by keeping your taxes as low as possible.

And then there’s harvesting losses. If you’ve been doing so regularly there may not be any losses to realize in your brokerage account since returns have generally been good this year. But if there are losses, you can sell and realize them along with gains. Doing so helps reduce your taxable gains because you claim the “net” number on your taxes. For example, if you sold some of your stock fund for a $5,000 long term gain, but then sold a bitcoin fund for a $4,000 loss, you’d only pay tax on the $1,000 difference.

Then if you really, really want to you can buy back the bitcoin fund. You just need to wait at least 30 days. Otherwise, the IRS will disallow the loss and call the transaction a “wash sale”, something to be avoided.

So, that’s one of the issues I’m spending time with as we look at closing out the year. Other issues like Required Minimum Distributions and Roth Conversions are present as well. We’ll touch on those in the coming weeks.

Have questions? Ask me. I can help.