Smart Tax Strategies for Investors: Capital Gains and Tax Loss Harvesting Explained

Building wealth is more than about just earning more money — it’s also about keeping more of what you earn on an after-tax basis. One of the most effective ways to do that is by understanding how taxes impact your investments. 

Two powerful strategies that you can use to reduce the taxes you pay on growth are capital gains management and tax loss harvesting.  Mastering these investment tax planning techniques can improve your long-term financial outcomes. 

Understanding capital gains 

Capital gains are the money you make when you sell an asset such as stocks, bonds, real estate, or mutual funds. You earn a profit when you sell the asset for more than you paid. These gains are categorized into two types generally based on how long you’ve held the investment. 

• Short-term capital gains: Profits from assets held for one year or less. Net short term gains are taxed at your ordinary income tax rate, which can be as high as 37% depending on your income bracket. 
• Long-term capital gains: Profits from assets held for more than one year. Net long term gains are taxed at preferential rates (like qualifying dividends), which may be 0%, 15%, or 20%, based on your taxable income. 

Netting outcomes

Netting happens within each category for reporting on your tax returns, with one of four possible outcomes: 

1. Net short-term gain and net long-term gain: You pay taxes on both amounts. The short-term gain is taxed at your ordinary income rate, while the long-term gain is taxed at the typically lower long-term capital gain rates. 
2. Net short-term loss and net long-term loss: You combine the two losses. You can deduct up to $3,000 of the total net loss against your ordinary income for the year ($1,500 if married filing separately). Any remaining loss is carried forward to future tax years. 
3. Net short-term gain and net long-term loss: The long-term loss offsets the short-term gain. If the loss is greater, you can deduct up to $3,000 of the remaining net loss against your ordinary income. If the gain is greater, the remaining gain is taxed at your ordinary income rate. 
4. Net short-term loss and net long-term gain: The short-term loss offsets the long-term gain. If the loss is greater, you can deduct of to $3,000 of the remaining net loss against your ordinary income. If the gain is greater, the remaining gain is taxed at the typically lower long-term capital gain rates. 

Understanding the differences in capital gain tax rates is crucial for tax-efficient investing. Holding an asset for just a few extra months could mean the difference between paying 37% or 15% in taxes. 

Planning timing of sales 

One of the simplest tax-smart investing strategies is strategic timing. If you’re approaching the one-year mark on an investment, consider waiting to sell until it qualifies for long-term capital gains treatment. If your income is low in a certain year, like during a sabbatical or job change, it may be a good time to take gains. This is especially true if you are in a lower tax bracket. 

Using tax loss harvesting strategy 

Tax loss harvesting is a strategy that involves selling investments that have declined in value to offset gains from other investments. This can reduce your taxable income and, in turn, your tax bill. 

Example: Let’s say Stock A sold for a $10,000 gain. If Stock B also sells for a $7,000 loss, there will be taxes on the net gain of $3,000. If the losses exceed gains, up to $3,000 of those losses can be used to offset ordinary income. Any remaining losses can carry forward to future years indefinitely.

A key caveat to tax loss harvesting is the wash sale rule. This IRS rule prohibits you from claiming a loss on a security if you buy the same or a “substantially identical” security within 30 days before or after the sale. To avoid this, consider buying a similar, but not identical, investment to maintain your portfolio’s exposure. 

Many financial platforms now offer automated tax loss harvesting, scanning portfolios daily for opportunities to sell losing positions and reinvest in similar assets. This can be beneficial in volatile markets, where frequent fluctuations create more harvesting opportunities. To avoid problems with tax treatment, reporting, and wash sales, it is best to talk to a financial advisor or tax expert. 

Preparing for capital gains distributions 

If you invest in mutual funds, be aware of capital gains distributions. These are gains realized by the fund manager from selling securities within the fund, which are passed on to shareholders — even if you don’t sell any shares yourself. These distributions typically occur at year-end and can trigger unexpected tax liabilities. 

To avoid the taxes, consider: 

• Buying mutual funds after their distribution date 
• Opting for tax-efficient funds or ETFs that minimize turnover 

Considering an asset location strategy 

Where you hold your investments matters. Tax-inefficient assets (like bonds or actively managed funds) are best placed in tax-advantaged accounts such as IRAs or 401(k)s. Meanwhile, tax-efficient assets (like index funds or stocks held for the long term) can be held in taxable accounts. 

This strategy, known as asset location, helps you minimize taxes while maintaining your desired asset allocation. 

Minimizing taxes with charitable giving 

If you’re charitably inclined, donating appreciated assets instead of cash can be a win-win strategy. You avoid paying capital gains tax on the appreciation and still receive a charitable deduction for the full market value of the asset as of the date of donation. This strategy may be beneficial for stocks that have seen significant growth.. 

Key items to consider here in addition to direct gifting to particular charities, are using a Donor Advised Fund (DAF) or one of the many types of charitable trusts.  

Managing tax brackets 

If you’re nearing retirement or planning a sabbatical, you may temporarily fall into a lower tax bracket. This is a prime opportunity to potentially gain long-term capital at a lower rate — or even at 0% if your taxable income is below the threshold. 

For 2025, the 0% long-term capital gains rate applies to: 

• Single filers with taxable income up to $48,350 
• Married couples filing jointly with income up to $96,700 

Learning about the net investment income tax (NIIT) 

The NIIT, when applicable, adds 3.8% to the taxes charged on net investment income when your modified adjusted gross income (MAGI) is over a certain income threshold.  

The following are the MAGI thresholds for individuals:  

• Married filing jointly: $250,000 
• Qualifying widow(er): $250,000 
• Single: $200,000 
• Head of household: $200,000 
• Married filing separately: $125,000  

These thresholds are not adjusted for inflation, so more taxpayers become subject to the NIIT over time.  

Estates and trusts
An estate or trust is subject to the NIIT if it has undistributed net investment income and its adjusted gross income (AGI) exceeds the dollar amount at which the highest tax bracket begins for that tax year.  

What is included in the NIIT? 

Investment income generally includes:  

• Capital gains from the sale of stocks, bonds, and other property 
• Dividends 
• Interest 
• Rental and royalty income (unless derived in an active trade or business) 
• Income from a business involved in trading financial instruments or commodities 
• Passive income from a business that you don’t actively participate in 
• Taxable portions of nonqualified annuity payments  

Some investment income is not subject to the NIIT, including:  

• Wages 
• Social Security benefits and unemployment compensation 
• Tax-exempt interest 
• Distributions from qualified retirement plans (like a 401(k) or IRA) 
• Income from an actively run business  

To calculate your net investment income, you must subtract eligible expenses — such as brokerage fees, investment advisory fees, and certain state and local taxes — from your gross investment income.  

How to calculate the NIIT 

The NIIT is 3.8% of the lesser of the following two amounts:  

• Your net investment income 
• The amount by which your MAGI exceeds the applicable threshold for your filing status  

Example:  A single filer with $250,000 in MAGI and $80,000 in net investment income would be taxed on the $50,000 by which their MAGI exceeds the $200,000 threshold, because that is the lesser of the two amounts. The tax in this case would be $1,900 ($50,000 x 3.8%).

You can calculate and report the tax using IRS Form 8960.  

Strategically realizing gains during low-income years can help save you money in taxes. 

Building wealth 

Taxes are one of the biggest drags on investment returns but they’re also one of the most controllable. By understanding how capital gains work and using tax-saving strategies like tax loss harvesting to reduce investment taxes, you can keep more of your money working for you. 

Whether you’re building a nest egg, saving for a major purchase, or planning for retirement, smart tax planning is an essential part of wealth building strategies. 

Getting guidance 

While the strategies outlined in this article can be powerful, they can also be complex to navigate on your own. 

At Mercer Advisors, we offer tax preparation  and planning services to our clients. Your wealth advisor collaborates with CPAs, Enrolled Agents and other tax professionals on staff to help: 

• Identify harvesting opportunities 
• Navigate the wash sale rule 
• Optimize your asset location 
• Plan for capital gains distributions 

They can also help you integrate these strategies into your broader financial plan, ensuring that your tax-saving efforts align with your short and long-term goals. 

If you’re not a Mercer Advisors client and want to know more about building wealth and minimizing your taxes with smart strategies, let’s talk.