Why harvesting capital gains matters

Harvesting capital gains during a low-income year is a tax-aware move that can materially increase your after-tax wealth. Federal long-term capital gains (LTCG) are taxed at 0%, 15%, or 20% depending on taxable income and filing status; those rates are indexed annually by the IRS. Realizing gains when you fall into the lower end of the income scale can mean paying little or no federal tax on those gains. (See IRS Topic No. 409 for details on capital gains tax rates.)

This strategy is not about chasing short-term returns. It’s about timing realizations to years when your ordinary taxable income is lower—examples include the first years of retirement, sabbaticals, career transitions, or years with unusually low wages or business income.

Who should consider this strategy

  • Investors with appreciated positions in taxable brokerage accounts.
  • People expecting a predictable low-income year (e.g., early retirement, unpaid leave, job change).
  • Taxpayers wanting to pair Roth conversions with one-time gains to use a low bracket efficiently.

It’s not ideal if selling forces you to rebuild a concentrated position at a worse price, triggers state-level taxes that erase the benefit, or if the gains are short-term (held ≤ 1 year), which are taxed at ordinary income rates.

Key tax mechanics to know

  • Long-term vs. short-term: Gains on assets held longer than one year receive long-term treatment and lower rates; assets held one year or less are short-term and taxed as ordinary income.
  • Federal LTCG rates: generally 0%, 15%, or 20% depending on taxable income; thresholds change each year (IRS Topic No. 409).
  • Net Investment Income Tax (NIIT): a 3.8% surtax can apply to high-income filers and may reduce or eliminate the advantage of harvesting gains in some cases (see IRS guidance on NIIT/Form 8960).
  • State taxes: many states tax capital gains as ordinary income—always check state rules.

Authoritative sources: IRS Topic No. 409 (capital gains) and Form 8960 guidance on NIIT. Links: https://www.irs.gov/taxtopics/tc409 and https://www.irs.gov/forms-pubs/about-form-8960.

A step-by-step planning checklist

  1. Confirm your expected taxable income for the year. Estimate Social Security, pension, wages, business income, retirement distributions, and ordinary dividends. Use conservative figures.
  2. Verify holding periods for positions you plan to sell. Long-term status (>
    12 months) is usually required to access favorable LTCG rates.
  3. Calculate the taxable gain you’d realize (sale price minus cost basis and any selling costs). Use tax-lot accounting to pick specific lots with favorable basis.
  4. Model the tax impact: apply expected federal LTCG rates for that year and add potential NIIT and state tax. Do several scenarios (best/mid/worst case).
  5. Coordinate other tax moves in the same year—examples include Roth conversions, required minimum distributions (RMDs), or tax-loss harvesting—to avoid pushing you into a higher bracket.
  6. Implement with a plan to rebalance: if you sell to reduce concentration, have a replacement strategy (different security or staged purchases) to avoid market-timing mistakes.
  7. Document everything and maintain records to support holding period and basis if the IRS questions your return.

Practical examples (illustrative)

  • Example A — Short, low-income year: You expect one calendar year between jobs with minimal earned income. You sell $50,000 of long-held index funds and realize a $20,000 long-term gain. If your other taxable income keeps you under the federal 0% LTCG threshold that year, the federal tax on that gain could be $0 (state taxes may still apply). This is illustrative—actual thresholds are set each year by the IRS.

  • Example B — Pairing with a Roth conversion: In a planned low-income year, you take a modest Roth IRA conversion and also realize gains in your taxable account. By modeling both moves together you can use the same low-tax bandwidth to convert tax-deferred funds and realize gains at favorable rates.

Always label numeric scenarios as illustrative and run a tax-model for your specific situation or ask a tax pro.

Interaction with tax-loss harvesting and wash-sale rules

Harvesting gains and tax-loss harvesting are complementary. You can sell losers to offset realized gains, lowering net taxable gains in a year. If you have more losses than gains, you can use up to $3,000 of excess losses against ordinary income in a tax year and carry forward the rest (rules may vary; see our detailed guides on tax-loss harvesting).

Note: the wash-sale rule applies only to losses. Selling appreciated shares does not trigger a wash-sale. For loss harvesting, see our piece “Tax-Loss Harvesting in Practice: When to Sell, When to Hold” for tactical workflows.

Helpful internal links:

Common mistakes and how to avoid them

  • Ignoring holding period rules: realize that short-term gains can be taxed at ordinary rates and may negate the benefit of harvesting in a low-bracket year.
  • Overlooking state taxes: a low federal bracket can be offset by high state tax rates; model both.
  • Rebuying the same position immediately without a plan: if you sell for tax reasons but still believe in the asset, rebuying at a higher price can hurt returns—consider staggered re-entry or using a similar but not identical fund.
  • Failing to aggregate income sources: one-time windfalls (a bonus, large IRA distribution, or Social Security) can push you into a higher bracket unexpectedly. Build margin into your estimates.

Tactical tips I use with clients

  • Use specific tax lots: pick lots with the lowest cost basis when you want larger gains and higher-basis lots when you prefer smaller gains.
  • Combine with Roth conversions: low-income years are also excellent windows for Roth conversions. Combining both moves uses the same lower-tax space efficiently.
  • Stage sales across calendar years: if you expect income to rise next year, realize part of a position now and the rest later to smooth tax exposure.
  • Watch for the NIIT cliff: model whether the 3.8% surtax applies, because it can quickly reduce the net benefit of harvesting.

When harvesting is NOT a good idea

  • If realizing the gains will trigger NIIT, an AMT-like outcome, or make you lose means-tested benefits (e.g., premium tax credits) in a way that outweighs the tax savings.
  • If transaction costs, bid-ask spreads, or the likelihood of repurchasing at a significantly higher price reduce expected after-tax returns.
  • When the sale harms the long-term strategy (e.g., selling a core holding that you intended to hold for decades) without a strong replacement plan.

Practical next steps

  1. Run a projected income model for the year(s) you consider harvesting.
  2. Identify candidate lots and calculate after-tax proceeds under conservative assumptions.
  3. Talk to a CPA or tax-focused advisor to confirm model inputs and timing—especially around NIIT and state tax issues.
  4. If you move forward, document cost basis, trade confirmations, and rationale for your file.

Professional disclaimer

This article is educational and does not constitute tax, legal, or financial advice. Tax rules change and thresholds are updated annually. Consult a qualified CPA or financial planner to model your specific situation before executing capital gains harvesting.

Sources and further reading

If you’d like, I can build a simple model you can plug your numbers into (income, expected gains, state tax) to show estimated federal tax on realized gains across two years.