Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

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Topic Author
dorster
Posts: 38
Joined: Tue Aug 15, 2017 4:20 pm

Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by dorster »

With my 403B and IRA deductions, I'm in the 12% federal tax bracket and live in a state with no income tax. When I stop working I'm planning on being able to convert all pre-tax savings to Roth within the standard deduction and being able to realize capital gains at the 0% long term capital gains (LTCG) rate. I have relatively low expenses, save a large-ish portion of my income, and plan to stop working a while before SS. My largest accounts are taxable (70%) followed by pretax (15%) and tax-exempt (15%).

Currently single but planning on marriage next year (we both have comparable incomes and savings so the tax situation actually doesn't change that much, I'll continue writing in the first person singular for clarity). My taxable income would allow for about $15,000 of LTCG harvested at the 0% rate. Same for partner/potential spouse.

I tax loss harvested (TLH) through late 2018 and early 2020 and have about $20,000 in banked losses (same for partner). We could use the $3,000 deductions for the next 7-14 years depending on marriage. What I'm trying to figure out is the trade-off between taking the $3,000 annual deduction from TLH which saves me about $360 in taxes now vs. tax gain harvesting (TGH) about $15,000 annually and increasing my cost basis. If we marry the deduction scales down from $3,000 each to only $3,000 combined but our 0% LTCG bracket space grows to $30,000 making TGH more compelling.

My thinking is that it's pretty likely that we will not live in a tax-free state forever. If I assume the state we move to taxes capital gains at 5.15%. Then I'm saving $772 by harvesting $15,000 in gains which is a better deal than taking $360 off my income taxes. If we marry this becomes $1,545 of potentially avoided future taxes annually in exchange for forgoing the same $360 income tax savings.

Am I thinking about this the right way? I've always thought that deferral of any tax that was >0% was the way to go so I'm having some trouble passing up current tax savings.

Disclosure of a seeming behavior pitfall:
Our portfolios are VTI and VXUS but due to TLH we have some S&P 500 funds and some developed market/EAFE funds (and the accompanying extended market and emerging market funds to approximate our portfolios back to the total market). It would be satisfying to move those back to total market funds and have the portfolio look "nice".
lakpr
Posts: 6203
Joined: Fri Mar 18, 2011 9:59 am

Re: Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by lakpr »

I have said this in multiple other posts -- the 0% LTCG rate bracket, and the 12% bracket, both compete in the same exact space. To the extent that you are choosing one, it pushes out the other.

In your case, I would choose to do Roth conversions of your earlier pre-tax assets (if you can) up to the top of the 12% bracket. Then, only since you said you will be moving to an income-tax state versus no-income-tax state currently -- I would realize the losses after the move. Yes, the gains in the new state will be taxed at 5.15%, but they are matched up against banked losses from previous years.

This way, you will be offsetting a capital gain that will be taxed in the future at 15% + 5.15% with your banked losses, rather than offsetting a gain now that will be taxed at 0% + 0%. Because the IRS rules dictate that you MUST match up losses from previous years against the gains from the current year before you can deduct them against the ordinary income. You don't have a choice there to stack the losses only against ordinary income.

This is why I push for Roth conversions in the 12% bracket up to the top of the bracket. Even if you do not have losses, it's an equation of no-tax-ever-in-the-future, at a cost of 12% of converted amount; versus a one-time break of 0% on the amount tax-gain-harvested, but ongoing taxes on the dividends and capital gains until you sell again.
Topic Author
dorster
Posts: 38
Joined: Tue Aug 15, 2017 4:20 pm

Re: Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by dorster »

Hi thanks for your response. Though I'm not sure I follow your logic.

I have relatively little pre-tax and will certainly be able to convert it all to Roth paying 0% federal tax just by filling up my standard deductions (plus any state tax). So I don't plan on accelerating those conversions and paying 12% now.

Let me rephrase my question:

I have about $20,000 in banked capital losses. Since I'm in the 12% tax bracket all this saves me in taxes is $360 per year. I also have about $100,000 in unrealized capital gains and the only reason I'm not tax gain harvesting those using space I have in the 0% LTCG tax bracket is that I would have to cancel out the $20,000 in TLH I did earlier this year.

Doesn't it make sense to realize gains for the next few years and dramatically increase my basis tax free? If I increase my basis by $15,000 every year that could save me from paying $750 in state income tax on those gains in the future. This seems like more of a benefit than saving $360 in fed income tax (and again, when married this benefit becomes more favorable).

Thanks for reading!
lakpr
Posts: 6203
Joined: Fri Mar 18, 2011 9:59 am

Re: Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by lakpr »

dorster wrote: Thu Nov 19, 2020 6:17 pm Hi thanks for your response. Though I'm not sure I follow your logic.

I have relatively little pre-tax and will certainly be able to convert it all to Roth paying 0% federal tax just by filling up my standard deductions (plus any state tax). So I don't plan on accelerating those conversions and paying 12% now.

Let me rephrase my question:

I have about $20,000 in banked capital losses. Since I'm in the 12% tax bracket all this saves me in taxes is $360 per year. I also have about $100,000 in unrealized capital gains and the only reason I'm not tax gain harvesting those using space I have in the 0% LTCG tax bracket is that I would have to cancel out the $20,000 in TLH I did earlier this year.

Doesn't it make sense to realize gains for the next few years and dramatically increase my basis tax free? If I increase my basis by $15,000 every year that could save me from paying $750 in state income tax on those gains in the future. This seems like more of a benefit than saving $360 in fed income tax (and again, when married this benefit becomes more favorable
Thanks for reading!
Re-reading your post very carefully ... I agree with you now. But I think all your conditions need to be met for your move to be financially beneficial:

- You will get married (you will therefore move from being able to claim $3000 * 2 in losses per year to only $3000 * 1 in losses per year)
- You will move to the new state which charges a 5.15% income tax rate (so $15k increase in gains, if realized in the new state, would cost you $775 in taxes)
- When you retire, your taxable withdrawals or Roth conversions will still place you in the 0% / 10 % / 12% brackets. This is the assumption that I was questioning ... the risks are that the 12% bracket will move to 15% bracket in 2026, the 10% bracket disappears, and you will also pay a 5.15% income tax in the new state for a net tax of 20.15% even at the lowest bracket if you exceed the standard deduction. The only sure fire way you will win would be if your Roth conversion amount + all other income is less than the standard deduction -- that. seems. stingy. Poverty type lifestyle .... and I have been assuming that at the barest minimum you WILL move into the 15% income tax bracket.

That's why I had been advocating doing Roth conversions now at 12% tax rate instead of paying a 20.15% tax rate in the future.
Topic Author
dorster
Posts: 38
Joined: Tue Aug 15, 2017 4:20 pm

Re: Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by dorster »

Thanks for your answer! I think you're now more understanding the question I was asking.

I guess everyone has different definitions of stingy and poverty type lifestyle, but doing Roth conversions up to the standard deduction (currently $24,800) and then selling taxable investments up to $75,000 in LTCG annually for spending money (all while paying zero federal income tax) doesn't meet mine. Chances are I'll need far less than that per year once I stop working.

If anyone else has any thoughts on using capital losses to offset income in the 12% bracket versus harvesting gains while still in a no income tax state I'd appreciate it!
jmg229
Posts: 329
Joined: Mon Jan 31, 2011 1:21 pm

Re: Tax Loss Harvesting vs Tax Gain Harvesting for lower income tax brackets.

Post by jmg229 »

I think your plan makes a lot of sense. We took advantage of all of the opportunities we had to harvest gains while we were in the 0% LTCG bracket, recognizing that our incomes would likely increase out of that bracket in the future. I think especially with no state income tax it makes sense.
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