THIS IS THE TIME of year when many folks rush to purchase last-minute gifts. Not me. While others are out buying, I’m at home selling. You see, this is when I make moves in my brokerage account to limit my tax bill.
What have I been up to? First, I logged on to my Schwab account and reviewed my year-to-date realized gains and losses. I had generated $8,000 in long-term capital gains earlier in 2021 by selling an appreciated exchange-traded fund. While I knew I was generating a gain at the time, I postponed any tax-loss selling—until now.
My next move was to look across my portfolio for any unrealized losses that could offset my $8,000 gain. Fortunately—although, at the same time, unfortunately—I was sitting on a sizable unrealized loss from a hotel-focused real-estate investment trust. I made the most of this negative position by selling a portion to fully offset the capital gain generated earlier in the year. Now, I’m contemplating selling more of this position to have a net capital loss of $3,000 in 2021. A net capital loss of up to $3,000 can be used to offset ordinary income.
My final step: Think about next year. In my case, I won’t have a material change in my income next year, so I’m not making any further moves in 2021. The situation is different for a close friend whose portfolio I recently reviewed. She’ll see her 2022 income spike because of a capital gain from a pending real estate transaction. Because of that gain, any capital gains from portfolio moves in 2022 will likely be taxed at 20%. As she’s looking to diversify away from stocks, she decided to take some gains in 2021 on a heavily appreciated S&P 500 fund. By making this move in 2021, she saves herself a decent amount, because the gains will be taxed at the lower rate of 15%.
A final note on last-minute selling: It’s the “trade date”—or the date on which a trade is executed—that dictates the year in which a gain or loss is calculated for tax purposes. As such, those of you who love to procrastinate can delay tax-related portfolio moves until Friday, Dec. 31.
I’ve been similarly busy, but in this case with tax gain harvesting, as I wrote about here. Using losses intentionally realized in the 2020 downturn, I sold down my holding in a somewhat tax inefficient mutual fund, and bought an index fund, with no tax consequences.
First, I set aside $3000 in losses to be applied to ordinary income, since that’s more valuable to us this year than offsetting capital gains. That established my target gain to realize.
Then, I looked at the cost basis of my fund and determined how much of my fund I needed to sell to realize my desired gain amount.
Since we can’t know the exact price at which a mutual fund will be at the end of the day, I sold in two tranches, the first about 80% of what I ultimately expected to sell, rechecking the new cost basis amount after the first sale.
This got to within $116 of my target, which meets my technical definition of “close enough,” so I won’t be selling a third tranche. That $116 will be carried over to offset other capital gains next year.
For those investors who hold mutual funds in a taxable account 2021 appears to be shaping up to have above average long term capital gain distributions. Those gains should also be considered in your tax loss harvesting plans.
Good article Kyle. One thing to remembers there may be state tax considerations, depending where you live. I remove years ago helping my mother-in-law figure out similar questions. I used to keep a “what if” version of her tax return to adequately model all the interconnections of a senior with a significant amount of medical deductions. Because of her high deductions we could often realize significant capital gains, but still keep her in the lowest income bracket and 0% Cap gain tax rate. She still paid thousands of dollars to state tax.
Good point Rick. Since many states treat capital gains as ordinary income you can easily end up paying more in state income taxes than in federal.