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We are full-blown into fall so why not talk a little about harvesting (see what I did there)?
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I am not talking about harvesting like that wooden sign you got from Hobby Lobby in your kitchen, we are going to talk about how to optimize your tax situation when investing.
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PSST: Now this is an advanced strategy, if you are new to investing donβt get caught up in the weeds. You need to focus on the basics first.
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So you probably have not heard much about tax gain harvesting (TGH), and if it's all sounding Greek to you, don't sweat it! We're here to decipher this financial jargon and make it as easy as pie.
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Unlike its sibling, tax-loss harvesting, which is all about making the best out of your investment losses, tax-gain harvesting helps you leverage the gains from your investments.
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Stick with us as we unravel what tax gain harvesting is all about, how it operates, its rules, and why it might just be a game changer in your investment journey.
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The ABCs of Tax Gain Harvesting:
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So, the star of our show, tax gain harvesting, is all about selling investments that have grown in value. The buzzword here is "cost basis," which is just a fancy term for the original value of an investment when you bought it. This cost basis helps figure out the capital gain or loss when you sell off that investment. For instance, if you snag a share of VTSAX for $100, thatβs your cost basis. Sell it for $110 and voila, youβve got a $10 capital gain.
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Now, tax gain harvesting steps into the spotlight to bump up your cost basis, aiming to shave off some of those capital gains taxes down the line, or to beef up a loss to harvest if the market decides to throw a curveball.
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How Does It Work?
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Hereβs where the magic happens. Tax gain harvesting involves selling off those blooming investments and immediately buying them back.
Doing this during the years when your assets are growing can hike up the cost basis of your investments, which could come in handy in lowering capital gains tax or boosting a harvested loss in the later years.
For instance, say Sam decided to do this during the good years (2004, 2005, and 2006) by selling and rebuying the same assets.
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This savvy move nudged the average cost basis of his investments from $26.42 to $29.74 per share, allowing him to harvest over $21,000 of losses at the end of 2008, compared to a lesser $14,000 without the tax gain harvesting shuffle.
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The Rulebook
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Now, every good strategy has its rulebook. One golden rule is to hold onto investments for at least a year before selling to qualify for the friendlier long-term capital gains tax rate. Rushing and selling investments held for less than a year could slap you with higher short-term capital gains tax rates.
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Unlike tax-loss harvesting, tax-gain harvesting isnβt tied down by the wash-sale rule, so you can rebuy the same asset right after selling it at a gain.
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Pros, Cons, and When to Do This:
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The spotlight on tax gain harvesting shines brightest for folks in the 0% long-term capital gains tax bracket, potentially cutting down future capital gains tax. But, you need to be careful so you donβt stumble into a higher tax bracket.
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The best time to do this hinges on your tax situation and how the market is moving. It is usually the right time during years of asset appreciation and for those in lower tax brackets.
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Conclusion:
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Tax gain harvesting might seem like a tough nut to crack, but it can be a nifty tool in your financial toolkit when the time is right.
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