Most investors know all about the tax reasons for "harvesting" capital losses. But if you're considering a sale of assets that have gained in value, keep in mind that harvesting long-term capital gains can offer tax advantages as well.
Capital gains and losses from securities transactions, as well as other disposition of capital assets, are used to offset each other. Thus, if you're showing a net capital gain for the year, you might realize a loss, especially at the end of the year. The loss can negate the gain plus up to $3,000 of highly taxed ordinary income. And any leftover losses can be carried over to use the following year.
On the other side of the ledger, short-term capital gains from sales of securities you've held for a year or less are taxed at ordinary income rates. But gains that qualify as long-term—from selling securities you've held longer than one year—are taxed under special rules.
If you're in one of the two lowest ordinary income brackets of 10% and 15%, your maximum tax rate on long-term capital gains is 0%. If you're in higher brackets, the news isn't quite as good, but in most cases long-term gains still are taxed at just 15%. And even if you're in the top income bracket of 39.6%, your maximum tax rate on long-term capital gains is 20%.
Suppose you're a joint filer with taxable income of $100,000 this year. That puts you in the 28% bracket. Harvest a long-term capital gain of $10,000 from a securities sale, and you'll owe tax of $1,500. That compares with a tax bill of $2,800 if you realize a $10,000 gain on short-term holdings.
But even long-term gains count as "net investment income" (NII) and could be subject to an additional 3.8% surtax. That tax applies to your NII or the amount by which your modified adjusted income exceeds $200,000, or $250,000 for those who file jointly, whichever is less. That extra tax could reduce the advantage of harvesting long-term gains.
And if you do realize a long-term gain, think twice before taking a loss on another holding to offset that gain. Capital losses are more valuable if they're used to absorb highly taxed short-term gains. If you've already taken a loss, you may want to consider whether it would make sense to use it by harvesting a short-term gain.
These rules could change, if and when Congress passes any of the tax reforms currently being debated. As possible changes come into focus, we can help you decide whether to make specific transactions you're contemplating this year.