If you want to cash out a winning investment and pocket the proceeds without paying Uncle Sam, here's how to do it.
Harvesting your capital gains in a taxable account is a strategy whereby taxpayers below a certain income threshold sell off winning investments that have risen in value – and can do so tax-free.
While you're reaping capital gains tax-free in the short term, this move – done correctly – can also help you cut your tax bill over the long term.
"There can be value to harvesting gains under the right circumstances," said Brian Ellenbecker, senior financial planner at Robert W. Baird & Co. in Milwaukee.
Taking gains off the table is the flipside of tax-loss harvesting.
When you harvest your losses, you sell the losing stocks in your taxable account and then use those losses to offset any capital gains you may have realized elsewhere in your portfolio.
In the event your losses exceed the gains, you can apply up to $3,000 a year to offset ordinary income.
Harvesting gains accomplishes a different goal.
In this case, taxpayers who have 2019 taxable income below $39,375 if they're single or $78,750 if they're married and filing jointly can cash out their winners with no federal capital gains taxes.
Don't forget that taxable income is what your income looks like after you've applied your deductions.
Since the standard deduction in 2019 is $12,200 for singles and $24,400 for married-filing jointly, it means you can have up to $51,575 in income if single ($103,150 if you're married), apply the deductions and get in below the income threshold for 0% capital gains taxes.
You might wonder why you'd sell a big winner if it's faring well.
Here's why: Your capital gains and the taxes you pay on them are based on the difference between your cost basis – the amount you paid for the asset – and its appreciation at sale.
The bigger the difference between the cost basis and your appreciation, the greater the capital gain realized and the higher the tax you pay upon sale.
If you sell the investment and then buy it back at a higher price, you will have reset your cost basis. By selling it when you're in a low tax bracket, you're doing it with no taxes on the appreciation.
That means when you're ready to offload that position for good at some date in the future, you'll pay less in capital gains taxes.
"You might get large deductions, or maybe you're in those years between retiring and drawing down Social Security," said Jeffrey Levine, CPA and director of financial planning at BluePrint Wealth Alliance in Garden City, New York.
"Maybe those are years where you have income that's a little bit low and now you can do something along the lines of taking and selling those capital gains at a 0% tax rate," he said.
The path to tax-free gains has plenty of landmines for the uninitiated, so don't go it alone. Work with your financial advisor or CPA.
For instance, while you may be able to take gains off the table without the IRS taking its share, your state might want its slice of taxes.
"You should make sure with your accountant that the numbers work and that the state income-tax implications are the same as the federal tax implications," said John Voltaggio, managing director at Northern Trust in New York.
For example: a married couple filing jointly with $20,000 of ordinary income and $50,000 of capital gains will have zero federal tax liability.
However, if they live in Illinois, they can expect to pay $3,240 in state taxes, Voltaggio said.
Another unintended consequence: You harvest a big pile of gains, boosting your income and setting yourself up for higher taxes on Social Security income or higher premiums for Medicare Part B (medical insurance) or Part D (prescription drugs).
Individuals with combined income between $25,000 and $34,000 ($32,000 and $44,000 if married and filing jointly) have to pay federal income tax on up to 50% of their Social Security benefits.
Those with combined income over the $34,000 threshold ($44,000 if married and filing jointly) pay taxes on up to 85% of their Social Security benefits.
Meanwhile, individuals with a modified adjusted gross income exceeding $85,000 ($170,000 for married couples) face higher Medicare premiums. Bear in mind that there's a two-year lag: Premiums for 2019 are based on your income from 2017.
"When you start getting into higher income thresholds, where you have limits related to adjusted gross income, that's when you need to watch out," said Dan Herron, CPA, principal of Elemental Wealth Advisors in San Luis Obispo, California.