Capital gains and losses offer a notable opportunity for such adjustments; proper management of these gains and losses can affect an investor’s net return and total tax liability.
Understanding the triggers of any taxable capital gains is a key starting point to determine what tax-planning strategies may be appropriate. For example, an investor who needs to draw from investment accounts to fund spending needs can direct proceeds from their annual rebalancing or mutual fund distributions to a cash account for future use rather than automatically reinvest the proceeds. This can help avoid additional transactions—and the taxes on them—in the future.
Also, “pay particular attention to short-term gains,” said Garrett Harbron, Vanguard’s head of global wealth planning methodology and coauthor of the research paper. Short-term gains “do not receive the preferential tax rates that long-term capital gains do, so steps should be taken to avoid them.”
Other capital gains takeaways to keep in mind:
- Watch out for cost basis. The default cost basis treatment for a given transaction may not be optimal for the investor, as other available options might be more tax-efficient. Evaluating positions at the tax-lot level, while time-consuming, may reduce the investor’s current-year capital gains tax liability and provide hidden opportunities for tax-loss harvesting.
- Take advantage of capital loss carryforwards. Ensure that capital losses are accounted for. They can be carried forward indefinitely, but you must use them when you have the opportunity or else they’re lost. An investor who has $10,000 in capital losses and $8,000 in capital gains needs to subtract the losses at tax-filing time; they are not subtracted automatically. If the losses aren’t subtracted, the IRS will consider them lost anyway. In other words, losses cannot be stockpiled for future use. Whether they’re used in a tax calculation or not, the IRS treats an investor as having used them.
Everyone wants to pay less in taxes. To achieve that, Greene said, “you have to look at it in the context of what you’re paying over a lifetime, because you might make sacrifices today so that, on the whole, you’re paying less in taxes,
“It’s still all coming out of your pocket, so if you can make adjustments today to lower tax totals in the future, you’re still lowering your overall taxes.”