The is not a post about a Roth IRA or Tax Loss Harvesting. On a quick side note: Tax Loss Harvesting may be my least favorite buzz phrase in our industry. It is classic smoke and mirrors babble that our industry is so incredibly gifted at producing. The money manager or the robo advisor platform uses tax loss harvesting as a selling point to use their services. The fact of the matter is that anyone who is managing money for people should automatically be looking for ways to minimize capital gains taxes. If that means using a loss in a bad pick to offset or lower the capital gains exposure when taking profit on a good one, then it should go without saying that the portfolio manager is going to do that.
Another way to avoid capital gains tax is to take advantage of the tax code. The first thing to note is that this applies only to long term capital gains. Your capital gains become long term capital gains after you hold a position for more than 1 year. That enables you to be taxed at the capital gains rate. If you take a gain in less than a year, your gain is taxed as income at your income tax rate. The long-term capital gains rate is 0% if you are married filing jointly and your income including capital gains is $78,750 in 2019 and will be indexed to $80,000 in 2020. The levels for single filers are $39,375 and $40,000, respectively. These income levels are net of any tax deductions you may have. The standard deduction for a married couple filing jointly in 2019 is $24,400 and $12,200 for single filers. In 2020, it is $24,800 and $12,400, respectively. If your income exceeds these levels, the capital gains tax rate is 15% and it increases to 20% if your income is over $434,551 for single filers and $488,851 for married couples filing jointly in 2019. The 2020 levels for the 20% capital gains tax are $441,451 and $496,601, respectively.
There are a lot of numbers in the prior paragraph so I will close with a couple of examples. My first example involves couple I work with that is currently carrying an unrealized long-term capital gain of approximately $40k. The husband is now retired and is collecting social security. He receives a small income from a board affiliation he has of approximately $22k. His social security income is approximately $30k. His wife does not currently have any income as she plans on beginning her social security in 2020. We would like to reallocate their account to a more income-based portfolio as they are using withdrawals from their joint account to supplement their retirement income. Their total income will be approximately $52k for 2019. If you add the $40k capital gain, they total $92k. When you subtract their $24,400 standard deduction, it takes their income below the $78,750 threshold for 0% capital gains tax. We were able to reallocate the account without incurring a capital gains tax. Needless to say, the clients were very pleased with our recommendation.
The second example is a completely different scenario and does not result in tax free capital gains. It is another retired married couple with a joint income of approximately $50k from their social security. They also received some final distributions from the sale of their business in the past couple of years. They have a sizable joint account with significant capital gains in it. Each year, we have a discussion with their accountant to determine how much reallocating we can do in their account throughout the year while keeping their capital gains rate below 20%.
In either scenario, we are saving our clients’ money in capital gains taxes. Unfortunately, we couldn’t eliminate the capital gains tax for the client with the higher income, but we were still able to manage their gains. Paying taxes is a product of making money so all isn’t bad. As always, you should consult with your tax advisor and/or your financial professional before implementing these strategies. Furthermore, if a financial professional is touting tax loss harvesting as a unique selling proposition, ask him or her to elaborate further. You might be surprised at what you hear.
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