A year-end stock review can be a powerful way to minimize your tax liability while optimizing your investment portfolio. Here are some effective strategies to lower your tax bill:
1. Harvest Tax Losses
- Sell underperforming stocks to offset capital gains.
- Use up to $3,000 in losses to offset ordinary income ($1,500 if married filing separately).
- Carry forward excess losses to future tax years.
Tax-loss harvesting can be an effective way to reduce your tax bill, but there are several common mistakes investors should avoid. One of the biggest pitfalls is violating the wash sale rule, which prohibits buying a “substantially identical” security within 30 days before or after selling it at a loss. This applies to purchases in taxable accounts, IRAs, and even a spouse’s account. To stay compliant, investors should either wait 31 days before repurchasing the same security or reinvest in a different but similar security.
Another mistake is overlooking mutual fund and ETF distributions, which often happen in December. Buying shares before the ex-dividend date could mean owing taxes on gains from distributions, even if the investment was only held for a short time. Similarly, investors sometimes trigger short-term capital gains by selling securities held for less than a year. Short-term gains are taxed at higher ordinary income rates, making it more tax-efficient to prioritize selling long-term holdings when possible.
2. Take Advantage of Long-Term Capital Gains Rates
- Hold investments for over a year to qualify for lower long-term capital gains rates (0%, 15%, or 20%).
- Consider selling stocks strategically if your income falls within the 0% capital gains tax bracket.
Taking advantage of long-term capital gains rates can be a smart tax strategy, but there are several common mistakes investors make that can reduce their benefits.
One major mistake is selling investments too soon and triggering short-term capital gains. If an asset is sold before being held for at least one year, the profit is taxed at higher ordinary income rates rather than the more favorable long-term capital gains rates. Investors should always check their holding period before making a sale.
Another common misstep is not considering income thresholds for capital gains taxes. Long-term capital gains are taxed at 0%, 15%, or 20% depending on taxable income, but some investors don’t time their sales strategically. For example, retirees or individuals with fluctuating income could sell investments in years when they fall within the 0% capital gains tax bracket, avoiding taxes altogether. Selling in a high-income year may unnecessarily push the gains into a higher tax bracket.
Some investors also fail to account for the Net Investment Income Tax (NIIT). This additional 3.8% tax applies to capital gains if modified adjusted gross income (MAGI) exceeds $200,000 for single filers or $250,000 for married couples filing jointly. Ignoring this threshold can lead to unexpected tax bills.
Another mistake is not utilizing tax-advantaged accounts when appropriate. While long-term capital gains rates are lower than ordinary income rates, they can still be avoided altogether in tax-free accounts like Roth IRAs. Selling investments within a taxable account rather than in a Roth IRA could result in unnecessary tax liability.
Investors also sometimes forget about state taxes on capital gains. While federal tax rates on long-term gains are favorable, many states still tax capital gains as ordinary income, increasing the overall tax burden. Failing to account for state taxes can lead to higher-than-expected costs.
A final misstep is not coordinating sales with other tax strategies, such as tax-loss harvesting. If investors sell appreciated investments for gains but don’t offset them with losses from underperforming assets, they may pay more in taxes than necessary. Proper tax planning can balance gains and losses for the most efficient outcome.
By understanding these common mistakes, investors can better position themselves to maximize the benefits of long-term capital gains rates and minimize their tax burden. Would you like help planning a tax strategy tailored to your investments?
Defer Capital Gains to the Next Year
- If you anticipate lower income in the following year, delay selling assets until after December 31 to push the tax liability forward.
3. Rebalance Your Portfolio Tax-Efficiently
- Shift investments within tax-advantaged accounts (IRA, 401(k)) to avoid triggering taxable events.
- Consider rebalancing with new contributions rather than selling existing assets.
Would you like assistance in analyzing your portfolio for tax-saving opportunities?
Our tax services include…
- tax planning sessions where we go through a tax planning checklist
- regular communication throughout the year
- strategy sessions depending on your books and financials
- tax preparation for individual and business taxes
- access to an online tax portal 24/7 which holds documents, filings, and transactions.