Capital Gains Taxes and Portfolio Rebalancing (2024)

FAQs

Capital Gains Taxes and Portfolio Rebalancing? ›

The major friction that investors face in rebalancing their portfolios is capital gains taxes. 1 An investor who has only capital losses can, without the payment of a capital gains tax, rebalance his portfolio to the uncon- strained optimal level of risk given the assumed structure of future tax liabilities.

Selling assets to rebalance a portfolio will generate trading costs and perhaps also capital gains taxes. Instead, investors should buy more stock with cash if they're underweighted in equities.

With some investments, you can reinvest proceeds to avoid capital gains, but for stock owned in regular taxable accounts, no such provision applies, and you'll pay capital gains taxes according to how long you held your investment.

Rebalance in tax-advantaged accounts

Because rebalancing can involve selling assets, it often results in a tax burden—but only if it's done within a taxable account. Selling these assets within a tax-advantaged account instead won't have any tax impact.

Consider your holding period. The easiest way to lower capital gains taxes is to simply hold taxable assets for one year or longer to benefit from the long-term capital gains tax rate.

A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.

Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.

Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.

How to pay zero capital gains tax? ›

For 2023, you may qualify for the 0% long-term capital gains rate with taxable income of $44,625 or less for single filers and $89,250 or less for married couples filing jointly. The rates use “taxable income,” calculated by subtracting the greater of the standard or itemized deductions from your adjusted gross income.

Frequently Asked Questions about Capital Gains Tax

As long as you sell your first investment property and apply your profits to the purchase of a new investment property within 180 days, you can defer taxes.

Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.

While rebalancing requires selling securities and paying taxes, investors should be careful not to assume that they can avoid taxes forever simply by not rebalancing. Taxes will be realized over time by both turnover within each manager's portfolio and from client withdrawals.

You should consider adopting a portfolio rebalancing strategy—even during down markets when it's tempting to let your “winners” keep growing while your “losers” are taking their lumps.

Research from Vanguard shows there is no optimal rebalancing strategy. Whether a portfolio is rebalanced monthly, quarterly, or annually, portfolio returns are not markedly different.

Essentially, rebalancing means selling some assets in your portfolio and buying others to help maintain your target asset allocation. This is especially important during times of significant market volatility. Understanding rebalancing–and doing it well–is important in helping you meet your investing goals.

Can I Rebalance My Portfolio Without Selling? Yes, you can rebalance your portfolio without selling. If you're adding new money into the portfolio, buy the asset class that is underrepresented. If you buy enough shares, you can return the funds or individual holdings back to their preferred asset allocation.

You should consider adopting a portfolio rebalancing strategy—even during down markets when it's tempting to let your “winners” keep growing while your “losers” are taking their lumps. That's because rebalancing helps you buy low and sell high—an investing adage that's easy to say and hard to do.

Conclusion. These portfolio strategies are helpful during a bear market and for any economic environment. Rebalancing and working with a financial partner are always good strategies to keep your portfolio on track to meet your goals.