I'm about to rebalance my portfolio of ETFs. For the selling part, I have several lots to choose from, and I'm not sure if it matters much which one I pick. All lots have long term capital gains.

Here is a hypothetical example:

  • Lot 1: $1000 value with gain of 50%
  • Lot 2: $1000 value with gain of 40%
  • Lot 3: $1000 value with gain of 30%
  • Lot 4: $1000 value with gain of 20%

If I want to sell $1000, should I pick lot 4 to minimize tax on capital gains? That seems right, but want to make sure I'm not missing something.

  • If all positions have long term capital gains then the one with the lowest gain is the one that incurs the lowest amount of taxes. – Bob Baerker Jul 9 '20 at 18:19

Assuming all four lots qualify for long-term capital gains tax treatment (i.e. they've all been held for more than a year), and assuming no other considerations, minimizing current taxes is the best approach. In that case, it would make sense to sell lot 4.

Why might you want to sell a different lot

  • You might be concerned that capital gains taxes would increase in the future. That might lead you to realize more gains now while the rate is low.
  • You expect your income in future years to be higher (or your current year income is very low). Your capital gains tax rate is based on your income. If you happen to have a very low income this year or expect to have a very high income in future years, you may want to realize more gains this year to take advantage of these differences. Practically, this isn't terribly common since the 15% long-term capital gains tax rate applies for a very large range of incomes (~$40,000 to ~$440,000 for single filers and ~$80,000 to ~$480,000 for married filers) but if you have a highly variable income stream or you've been hit by the COVID pandemic, it is something to consider.

In a nutshell, all those gains are taxable one day - your choice is just which can you want to kick down the road.

The optimization depends on how you expect your future tax situation to be - if you expect to be in a higher tax bracket, it is better take the bigger gains now; if you expect to be in a lower tax bracket, take the smallest hit now.
This is of course not easy to predict, but you should have an idea if you might be getting a higher salary, or stop working, or whatever.

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