Why rebalancing across account types matters

Rebalancing is more than restoring percentages. When you manage multiple account types — taxable brokerage, Traditional or Roth IRAs, and employer plans (401(k)/403(b)) — the tax profile of each account changes the cost of trading. Taxable accounts trigger capital gains, while tax‑advantaged accounts generally permit tax‑deferred or tax‑free growth. By consciously allocating assets by account type (a practice called asset location) you reduce future tax drag and can rebalance with fewer taxable events (see the Asset Location Playbook linked below).

Federal guidance clarifies tax differences: long‑term capital gains in taxable accounts are taxed at 0%, 15%, or 20% depending on taxable income, while ordinary interest and short‑term gains are taxed at ordinary rates (IRS; see Tax Topics) — an important distinction when deciding where to hold bonds, REITs, and actively traded funds (IRS: https://www.irs.gov/taxtopics/tc409).

Core principles (quick rules of thumb)

  • Put tax‑inefficient assets (taxable interest, high‑yield bonds, REITs, MLPs) in tax‑advantaged accounts when possible. This defers ordinary income tax. (See IRS retirement plan guidance: https://www.irs.gov/retirement-plans.)
  • Hold tax‑efficient, growth‑oriented assets (broad index equity ETFs/funds meant for long‑term capital gains) in taxable accounts when appropriate — they benefit from favorable capital gains treatment and can be managed with tax‑loss harvesting.
  • Preserve cost‑basis and tax lots in taxable accounts to reduce realized gains when you must sell (use specific‑lot accounting where available).

Step‑by‑step rebalancing process for multiple accounts

  1. Establish a consolidated target allocation. Combine all accounts to get a household allocation (e.g., 60% equities, 40% fixed income).
  2. Calculate current allocation across all taxable + tax‑advantaged accounts. Include cash and short‑term bonds.
  3. Identify gaps by asset class and by account. Which accounts are overweight equities, bonds, or alternatives?
  4. Decide on the rebalancing approach: use new contributions and dividends first, then tax‑advantaged trades, and last consider taxable account sales that would trigger gains.
  • Use new contributions: Direct new contributions to underweight asset classes in the accounts where those asset classes should live. This is often the lowest‑cost way to rebalance.
  • Reallocate within tax‑advantaged accounts: Buy and sell freely inside IRAs and 401(k)s because trades are tax‑neutral.
  • Use taxable account strategies last: When you must alter holdings in a taxable account, prefer tax‑loss harvesting, specific tax‑lot sales (to maximize long‑term gains treatment), or selling assets with minimal gains.

In my practice, I find clients can avoid most annual taxable events simply by prioritizing new contributions and rebalancing within IRAs/401(k)s.

Practical examples

Example A — Using contributions to rebalance

  • Household target: 60% stocks, 40% bonds
  • Holdings: 401(k) has 80% stocks; taxable account has 70% bonds and cash
    Action: Direct future 401(k) contributions into bond funds or reallocate existing 401(k) positions to reduce equity exposure (no immediate tax cost). Use taxable account purchases to increase equities slowly only if that minimizes realized gains.

Example B — Tax‑efficient sale from a taxable account

  • You need $20,000 in rebalancing from a taxable brokerage that holds two lots of the same ETF: one purchased 8 years ago (cost basis low) and one purchased last year (higher basis).
    Action: Sell the lot with the smaller long‑term gain (or harvest losses elsewhere) and replace with an ETF of similar market exposure if required. If selling will create a large long‑term gain but the tax cost is acceptable relative to rebalancing benefits, proceed — otherwise delay or use contributions.

Tax techniques to reduce frictional costs

  • Tax‑loss harvesting: Harvest losses in taxable accounts to offset realized gains (subject to wash‑sale rules). The IRS tightens wash‑sale treatment and disallows loss deductions if substantially identical securities are bought within 30 days (IRS: wash sale information). Maintain a loss‑harvesting log and be mindful of ETF/replacement purchases.
  • Specific‑lot accounting: In taxable accounts, designate which shares are sold (FIFO vs specific identification) to minimize tax. Most brokerages support specific‑lot sales.
  • Use Roth conversions tactically: Small Roth conversions in low‑income years can shift future growth into tax‑free space, improving long‑term rebalancing flexibility. Conversions themselves are taxable events; coordinate with tax planning.

Rebalancing cadence and triggers

Choose a rebalancing schedule that balances tax costs, trading costs, and drift risk. Common approaches:

  • Calendar rebalancing: quarterly or annually. Simple and predictable.
  • Threshold rebalancing: rebalance when an asset class deviates by X percentage points from target (e.g., +/- 5%). Keeps allocations tighter but may increase trading.
  • Hybrid: check quarterly, rebalance only when thresholds are exceeded.

For multi‑account households, I recommend an annual comprehensive review with smaller intrayear checks tied to contributions. This reduces tax turnover while keeping allocation within tolerance (see our piece on Rebalancing Schedules for more on frequency).

Internal resources: For more on frequency and rules of thumb, see Rebalancing Schedules: How Often and Why It Matters (https://finhelp.io/glossary/rebalancing-schedules-how-often-and-why-it-matters/).

Where to place common asset types (asset‑location playbook)

  • Stocks (broad index ETFs): Good candidates for taxable accounts due to long‑term capital gains and qualified dividends. Keep highly taxed active equity in tax‑advantaged accounts.
  • Bonds and high‑yield fixed income: Prefer tax‑advantaged accounts to avoid ordinary income tax on interest.
  • REITs and MLPs: Often tax‑inefficient; consider tax‑advantaged accounts or use tax‑efficient wrappers in taxable accounts.
  • International equities: Dividends may carry foreign tax credits; hold based on the whole‑portfolio tax profile.

See our Asset Location Playbook for detailed guidance and examples: https://finhelp.io/glossary/asset-location-playbook-where-to-hold-stocks-bonds-and-alternatives/.

Handling special situations

  • Large concentration or employer stock: Consider net unrealized appreciation rules for employer stock in qualified plans and potential tax strategies for diversifying concentrated positions.
  • Required Minimum Distributions (RMDs): For Traditional accounts subject to RMDs, plan rebalancing around withdrawals to avoid forced sales at inopportune times.
  • Taxable events near year‑end: Watch timing of sales and harvests — deferring a sale into the next calendar year can shift tax liability if your income changes.

Tools and recordkeeping

  • Use consolidated reporting or spreadsheet to track household allocation, cost basis, and tax lots.
  • Enable specific‑lot reporting and keep a running list of replacement trades for loss harvesting to avoid wash sales.
  • Many brokerages and robo‑advisors offer tax‑aware rebalancing features. Read vendor disclosures and confirm they align with your tax goals.

Common mistakes to avoid

  • Treating every account in isolation rather than the household as a whole.
  • Triggering taxable gains unnecessarily when contributions or internal reallocations would suffice.
  • Ignoring wash‑sale rules when harvesting losses (IRS guidance: wash sales).
  • Over‑rebalancing in taxable accounts and creating short‑term capital gains.

When to seek professional help

If you have complex situations — large concentrated positions, multiple taxable trusts, or are considering substantial Roth conversions — consult a tax professional or CFP® who can model tax outcomes. In my work with families juggling multiple accounts, a simple projection of tax costs versus rebalancing benefits often changes the recommended order of operations.

Further reading

Authoritative sources

Professional disclaimer
This content is educational and does not constitute personalized financial, tax, or investment advice. Consult a qualified tax advisor or financial planner for recommendations tailored to your circumstances.

(Last reviewed: 2025)