Stacked Up Some Massive Capital Gains? 3 Ways to Take Some Chips Off The Table Tax-Efficiently

With markets at nosebleed levels and correction whispers growing louder, there’s plenty for savvy investors to worry about. Indeed, for those who may be sitting on a pile of  massive capital gains, there won’t be many tears shed. Indeed, that’s a great problem to have.

However, the reality is that some investors may feel that now is the right time to take some chips off the table, or lock in profits, while avoiding as much of the long arm of Uncle Sam as possible. In researching this topic, I’ve come across three pertinent pieces of advice I think can work for most investors.

Here’s what the research says may be the best order of operations for those who find themselves in this fortuitous, yet scary, situation.

Tax-Loss Harvesting

The first key item I think most investors will want to consider on their to-do list is to consider harvesting losses from other investments that may have declined in value, to offset some of the capital gains generated from smart investments over the years. 

The key to selling underperforming holdings at a loss and using those losses to cancel out capital gains on a dollar-for-dollar basis is to bring one’s capital gains level down as close as possible to zero. Additionally, it’s possible to use $3,000 of capital losses per year to offset other ordinary income, so there’s the potential here with such a strategy to actually lower one’s overall tax burden by selling the right securities at the correct time.

For investors who have been in the market for a long time and may not have many holdings currently trading at a paper loss, this strategy is one that can’t be employed. However, most financial and tax experts I see online do suggest to have a look at one’s cost basis for all portfolio holdings first before taking massive capital gains. This is the sort of low-hanging fruit which can save investors a lot of money.

One caveat to note is that wash sale rules put a limit on buying back a given security after selling for a period of 30 days. Personally, I like to wait six weeks to add back a position (or choose another very similar investment for the six week window, to maintain exposure, if desired). 

Donate Significantly Appreciated Stock To a Good Cause

For those investors who are more charitably minded, donating stock which has appreciated significantly in value can assist in lowering one’s overall tax burden (while also providing tax breaks, for those who itemize). Again, there are some caveats here worth noting, though the tax laws have changed after Trump’s recent tax bill was passed. As always, it’s best to discuss one’s philanthropic strategies or other tax saving moves with a professional. 

That said, donating shares which are considered long-term holdings (held for longer than a year) can be deducted pup to full fair market value, or 30% of adjusted gross income. For philanthropists with bloated portfolios, donating stocks that have appreciated significantly in value can be one way to avoid the big capital gains bill at the end of the year (and giving cash instead).

Another option is to consider setting up a donor-advised fund, which allows investors to lump their charitable giving in a good year with high ordinary income. By lumping one’s charitable giving up front, and then spreading that money out in future years, it’s possible to generate higher tax benefits in the near-term, which is what readers with big gains will presumably be looking to do. 

Take Your Gains Slowly Over Time

For those with time on their side, and no rush to liquidate highly-appreciated assets in the near-term, the third (and perhaps best option for the majority of readers) would be to take capital gains slowly.

Knowing which tax bracket one is in, it may be possible to take capital gains up to the next tax bracket level, paying minimal tax on an adjusted basis. For those who may have a little of room left at the 12% rate, or even the 22% rate, taking capital gains at a lower marginal tax rate can save one money over the long-term, so long as one maximizes their current tax bracket and are comfortable with that specific hit.

Notably, spreading sales over multiple years can help investors manage brackets and dodge the 3.8% Net Investment Income Tax (NIIT) threshold. This amounts to$200,000 for single filers and $250,000 for joint filers on a MAGI basis. The strategy most financial experts suggest is to sell just enough each year to stay in the 0% or 15% long-term gains bracket (under ~$50K taxable income for singles). Gradually trimming those mega-winners without spiking your rate from 15% to 20% is great advice, and I agree.