Minimizing capital gains is foremost in the minds of many investors with taxable accounts when December 31st approaches. This is particularly true for short term capital gains on assets held less than a year. While profit taking stems from many reasons, there are common strategies that help offset or minimize your taxable burden.
Here are some tax efficient strategies to consider:
Tax Loss Harvesting:
When short term capital gains are realized, you can apply up to $3,000 in losses from other investments against ordinary income for that year. Any remaining balance of losses can be carried forward to future years. Investment managers such as Elliott Broidy and smaller investors alike can benefit from tax strategic selling. Profit taking and tax loss harvesting may have similar motives. These can include changes in the underlying security and portfolio rebalancing, among several others. Aside from reducing the impact of capital gains, harvesting losses helps investors evaluate if current portfolios match their existing income tax brackets, time horizons and other considerations. Harvesting tax losses also gives financial incentive for parting with lackluster holdings you may be emotionally attached to.
Specific Identification Method:
Some investors sell portions of their holdings to take profits for various reasons. When doing so, the IRS assumes FIFO (First in First Out) when you sell securities. However, this may not have the most favorable cost basis, meaning these shares were purchased at a relatively low price and have more embedded capital gains. By identifying specific shares bought at higher prices, you can minimize taxes and still realize the needed amount for profits. The reasons for profit taking may include tweaking asset allocation, personal use, eliminating debt and meeting other tax liabilities, among others. Investors should determine where the money from their sales will be directed and how much is needed. Knowing the answers to such questions helps specific identification be more effective.
Tax efficiency is a crucial and dynamic aspect of an overall investment strategy. Understanding your tax liability is more effective when considered throughout the year, instead of hectic adjustments near December 31st. Methods such as tax loss harvesting and specific identification should be considered on an individual basis.
Please consult with a tax professional as needed.