Tax gain harvesting in low income years

In short

A friend of mine once told me he feared the tax bill more than the market, and I understood him. If you are holding shares in a regular brokerage account that have grown in value, you may owe tax when you sell them. In some years that tax rate can be zero. Tax gain harvesting means selling shares at a profit on purpose in a low income year, to use that low rate. The seller then buys the same shares back, and the new cost basis (the price used to measure future gain) is higher. That can shrink a later bill. It works only for shares held more than one year in a taxable account. Whether it helps depends on your income, your state, and the rules that apply to your own return.

The whole of it

What it is

I once watched a neighbor hold a field fallow for a season, just to let the soil rest. Tax gain harvesting is a bit like that, only the rest is for your tax rate. When you sell something for more than you paid, the profit is a capital gain. If you held the asset more than one year, the profit is a long term gain, and the law taxes it at lower rates than ordinary pay. Those rates come in steps, and the bottom step is zero percent. The zero percent rate applies when your taxable income falls under a set line, and that line depends on your filing status. The IRS publishes it each year in Publication 550 and in the instructions for Schedule D.

So the idea is plain. In a year when your income is low, you sell some winning shares, report the gain, and pay nothing federal on the part that fits under the zero percent line. Then you can buy the shares back right away. Your gain is now locked in, and your cost basis is reset to the higher price. Someday, when your income is higher, you will owe tax only on growth after that reset. You have probably heard this called a way to wash out old gains. It does not erase them forever. It moves the tax to a year when the rate was lower, and sometimes to a rate of zero.

How it works

If you are in a year with less income than usual, this part is for you. Maybe you retired early. Maybe you took a year off to care for a parent, or your business had a slow stretch. Your taxable income is what is left after the standard deduction or your itemized deductions. The zero percent rate on long term gains applies up to a threshold of the current figure, which the official source publishes each year for a single filer and the current figure, which the official source publishes each year for a married couple filing jointly. Those figures change by year, so check the IRS page for your year.

Here is the catch that trips people up. Gains get stacked on top of your other income. Your ordinary income fills the bottom of the stack first. The gain sits above it. Only the part of the gain that still fits under the line is taxed at zero percent. The part that pokes above the line is taxed at the next rate, which is the current figure, which the official source publishes each year for most filers.

A buyback is also simpler than it sounds. The wash sale rule, found in section 1091 of the Internal Revenue Code, bars a loss when someone buys the same security within thirty days. It applies to losses. A gain is not blocked. So the seller may sell at a profit and buy back the same day. That is why this move is different from harvesting a loss.

Now, a word about what a bigger gain can touch. A realized gain raises your adjusted gross income. That can change other things that read from that number. It can shrink credits, change the cost of marketplace health insurance, and raise Medicare premiums for people on Medicare. Net investment income tax can also apply at higher incomes. The IRS describes it on its page for that tax and in Form 8960. So a zero percent federal rate does not always mean a zero cost overall.

The numbers, and where to find yours

I have learned that a good number is one you can check yourself. Three figures matter here. The first is your filing status threshold for the zero percent rate, which is the current figure, which the official source publishes each year for a single filer this year. The second is your standard deduction, which is the current figure, which the official source publishes each year for a single filer. The third is your cost basis in each lot of shares, which sits on your brokerage statement and on Form 1099-B.

The IRS sets the thresholds each year in a revenue procedure, and it posts them in Publication 550 and in the Schedule D instructions. Your state may tax capital gains as plain income, and some states do not follow the federal zero rate at all. Your state revenue department publishes its own rules. To find your taxable income, take Form 1040 and read the line labeled taxable income. A tax software run with a pretend sale will show the effect before any money moves. Try the pretend version first. It costs nothing.

A worked example

Let me tell you about a woman I will call Ruth. She is single and she left her job in March. For the rest of the year she lived on savings and some part time work. Her wages came to $18,000 for the year. She also held shares of a fund in a taxable account that she bought years ago for $20,000. The shares are now worth $35,000.

Her standard deduction is the current figure, which the official source publishes each year. For this example, say that figure is $15,000. Her wages of $18,000 minus the $15,000 deduction leave $3,000 of taxable income before any sale.

Say the zero percent line for a single filer is $48,000 of taxable income. That is a made up round figure for the story. Ruth has room under the line of $48,000 minus $3,000, which is $45,000.

Her unrealized gain is $35,000 minus $20,000, which is $15,000. That is less than $45,000. So she can sell the whole position, report a $15,000 gain, and have her taxable income rise from $3,000 to $18,000. All $15,000 of it falls under the line. Her federal tax on the gain is $15,000 times 0 percent, which is $0.

She buys the shares back the same day for $35,000. Her new basis is $35,000. If the shares rise to $50,000 someday and she sells, her gain will be $50,000 minus $35,000, which is $15,000, not $30,000. That is the benefit. The $15,000 of old growth will never be taxed.

Now the care Ruth took. She checked whether her state taxes the gain. She checked whether the added $15,000 of income would change her health insurance help. She also kept the sale records. A friend of hers sold first and asked later. That order is backwards.

Where it goes wrong

I have seen plenty of good plans trip on a small step. The first is the stacking mistake. Someone thinks the whole gain is taxed at zero, but part of it lands above the line and is taxed at the current figure, which the official source publishes each year. Run the numbers before the sale, not after.

The second is the short term trap. Shares held one year or less produce short term gains, and those are taxed as ordinary income. They do not get the zero percent rate. Count the holding days on each lot.

The third is the side effects. A bigger adjusted gross income can reduce tax credits, raise the cost of marketplace insurance, or lift Medicare premiums two years later. The Social Security Administration publishes the income bands for Medicare premium adjustments. Read them.

The fourth is state tax. Some states tax every dollar of gain. A federal zero can still leave a state bill.

The fifth is the buyback itself. Buying back costs fees, and the shares may move in price between the sale and the buy. A same day buy trims that gap. It does not remove it.

The last is plain. Selling a good thing to save a little tax can cost more than it saves. A zero rate is only worth the trouble if the future saving is real. Keep it honest.

Questions to answer before you leave this page

What is my filing status, and what is the zero percent line for my own year on the IRS page? How much taxable income do I have before any sale, and how much room does that leave under the line? How long have I held each lot, and are all of them past one year? What is my cost basis in each lot, and does my brokerage statement agree with my own records? Will the added income change my credits, my health insurance help, or my Medicare premium? Does my state tax the gain, and at what rate? Have I run a pretend sale in tax software, and did I read the result line by line? And would a tax professional, one who knows my full return, see something I have missed?