Carryover losses and tax gain harvesting

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jaj2276
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Carryover losses and tax gain harvesting

Post by jaj2276 »

I read the wiki on tax gain harvesting but I'm not clear on when someone should use realized losses.

My situation is I'm in the highest federal tax bracket, in a 7% state tax bracket, and get hit with a significant amount of NIIT and add'l medicare tax. Last year I had the opportunity (sold on March 20, 2020) to take losses for the first time in a long time. This year I've also had the chance to take add'l losses. I took no realized gains last year and had not planned to take any gains this year or in any future year until I stopped working. My default thinking was I'd take the $3k against ordinary income each year and then offset against any realized gains in the future when I needed to realize those gains.

Is that the best approach? Or should I always tax gain harvest each year up to the amount of losses I currently have available? My investments are in ETFs which are super tax efficient so I hardly ever get capital gains distributions. I had incorrectly thought that all the dividends from my ETF investments could be offset against these realized losses but clearly that's not the case.
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grabiner
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Re: Carryover losses and tax gain harvesting

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There is no purpose in using up carryover losses to tax gain harvest. If the carryover losses are still there when you eventually sell, they will offset an equal amount of capital gains, so you break even. If the carryover losses have been exhausted, you got to deduct $3K per year from your ordinary income because you had the carryover losses, and you now pay tax on an equal amount of capital gain, at a lower rate and years later, so you come out ahead.

However, if you have some other reason to take a gain, carryover losses make it less costly. For example, if you need to either sell stock or take out a loan, carryover losses reduce the cost of selling stock. If you want to get rid of a fund with capital gains (and don't want to donate it to charity), you can sell it to buy a different fund and avoid paying taxes on the gain.

(State taxes may be an exception. NJ, for example, allows capital losses to offset gains only in the same year, with no carryovers, so you may benefit from tax gain harvesting on your NJ state tax.)
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jaj2276
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Re: Carryover losses and tax gain harvesting

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grabiner wrote: Sun Oct 24, 2021 12:35 pm There is no purpose in using up carryover losses to tax gain harvest. If the carryover losses are still there when you eventually sell, they will offset an equal amount of capital gains, so you break even. If the carryover losses have been exhausted, you got to deduct $3K per year from your ordinary income because you had the carryover losses, and you now pay tax on an equal amount of capital gain, at a lower rate and years later, so you come out ahead.

However, if you have some other reason to take a gain, carryover losses make it less costly. For example, if you need to either sell stock or take out a loan, carryover losses reduce the cost of selling stock. If you want to get rid of a fund with capital gains (and don't want to donate it to charity), you can sell it to buy a different fund and avoid paying taxes on the gain.

(State taxes may be an exception. NJ, for example, allows capital losses to offset gains only in the same year, with no carryovers, so you may benefit from tax gain harvesting on your NJ state tax.)
Thanks, seems like I am doing it correctly then (i.e. not forcing TGH just to eat up current year's TLH and carryover losses).

The wiki on tax gain harvesting had a note/section that made me think I was not doing it correctly:
The benefits of Tax Loss Harvesting followed by Tax Gain Harvesting (in a later year) are in opposition; they tend to cancel each other out. This does not preclude an investor with carryover losses from Tax Gain Harvesting, but it does raise a red flag for further investigation.
Conversely, if Tax Gain Harvesting is followed by Tax Loss Harvesting (with no prior carryover losses), both strategies are working in concert. After Tax Gain Harvesting, you've raised your cost basis; which makes it easier to harvest losses later. And later losses may be worth more, if your tax bracket or Long Term Capital Gains tax rate is higher.
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Re: Carryover losses and tax gain harvesting

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jaj2276 wrote: Sun Oct 24, 2021 11:10 am My situation is I'm in the highest federal tax bracket, in a 7% state tax bracket, and get hit with a significant amount of NIIT and add'l medicare tax.
grabiner wrote: Sun Oct 24, 2021 12:35 pm There is no purpose in using up carryover losses to tax gain harvest. If the carryover losses are still there when you eventually sell, they will offset an equal amount of capital gains, so you break even.
If you are in a zero or low tax bracket I believe it is sometimes beneficial to take losses annually because it may reduce the amount of social security that is subject to tax.

David's my tax guru he may be able to amplify or correct.
A scientist looks for THE answer to a problem, an engineer looks for AN answer and lawyers ONLY have opinions. Investing is not a science.
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Re: Carryover losses and tax gain harvesting

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Doc wrote: Sun Oct 24, 2021 1:13 pm
jaj2276 wrote: Sun Oct 24, 2021 11:10 am My situation is I'm in the highest federal tax bracket, in a 7% state tax bracket, and get hit with a significant amount of NIIT and add'l medicare tax.
grabiner wrote: Sun Oct 24, 2021 12:35 pm There is no purpose in using up carryover losses to tax gain harvest. If the carryover losses are still there when you eventually sell, they will offset an equal amount of capital gains, so you break even.
If you are in a zero or low tax bracket I believe it is sometimes beneficial to take losses annually because it may reduce the amount of social security that is subject to tax.

David's my tax guru he may be able to amplify or correct.
In the case that was quoted, it makes no difference. Say that you have $19,000 of carryover losses in 2021, and you can sell in 2021 for $10,000 of gains. In 2024, the stock goes up an additional $5000 and you need to sell it. If you sell in 2021, you have $9000 of carryover losses to use in 2021-2023, and a $5000 gain in 2024. If you don't sell in 2021, you have $9000 of carryover losses to use in 2021-2023, and your 2024 sale has a $15,000 gain, which is offset by the remaining $10,000 loss, leaving you with a $5000 taxable gain.

However, in the other case, it is possible for the phase-in of SS taxation to make a difference:
grabiner wrote: Sun Oct 24, 2021 12:35 pmIf the carryover losses have been exhausted, you got to deduct $3K per year from your ordinary income because you had the carryover losses, and you now pay tax on an equal amount of capital gain, at a lower rate and years later, so you come out ahead.
The "at a lower rate" is a usual assumption, which is the reason it is better not to harvest. If your marginal tax rate on ordinary income in the year of carryover losses is lower than your marginal tax rate on capital gains in the years of the sale, you might benefit from harvesting.

Consider the example above, with only $16,000 in carryover losses. Now, if you sell in 2021, you have no carryover loss in 2023, and $5000 capital gain in 2024. If you sell in 2024, you have a $3000 carryover loss in 2023, and an $8000 capital gain in 2024. If it happens that you are in the 22% tax bracket in 2023, and you start SS in 2024 and are in the phase-in of SS taxation, your marginal tax rate in 2024 on long-term gains is 33.7% (15% tax, plus every $1 makes 85 cents of SS taxable at 22%), so you are better off tax gain harvesting.

This can also happen without SS, if you are in the 12% tax bracket in 2023 and the 15% tax bracket for long-term gains in 2024.

However, neither of these is a common situation, so it is generally better not to harvest gains to offset losses unless you have some other reason (such as living in NJ).
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Re: Carryover losses and tax gain harvesting

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grabiner wrote: Sun Oct 24, 2021 2:29 pm However, neither of these is a common situation, so it is generally better not to harvest gains to offset losses unless you have some other reason (such as living in NJ).
That's why I left New Jersey after college. :D

By the way David, you moved out of Jersey a decade or more ago. Is Jersey still giving you nightmares? :D
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Re: Carryover losses and tax gain harvesting

Post by grabiner »

Doc wrote: Sun Oct 24, 2021 3:24 pm
grabiner wrote: Sun Oct 24, 2021 2:29 pm However, neither of these is a common situation, so it is generally better not to harvest gains to offset losses unless you have some other reason (such as living in NJ).
That's why I left New Jersey after college. :D

By the way David, you moved out of Jersey a decade or more ago. Is Jersey still giving you nightmares? :D
No, but it often comes up in tax-related discussions here, because NJ taxes work differently from federal taxes in several areas.
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