How to Reduce Taxes in a Taxable Brokerage Account

A taxable brokerage account gives you more flexibility than any retirement account. There’s no contribution limit, no income restriction and no required withdrawal date, which makes it a useful place to invest for goals that are several years away. The trade-off is that the tax treatment isn’t handled for you. In a 401(k) or IRA, the rules decide when you pay tax. In a taxable account, that depends on what you hold, which shares you sell and when you take money out.

A common misconception is that the tax bill on a brokerage account is whatever it turns out to be. In practice, most of the surprises I see come from decisions people didn’t realize they were making: a withdrawal without checking which shares got sold, a mutual fund that paid out gains in a year it lost money, a rebalance that could have waited. Each is a choice, and each can be planned. The goal is to keep your money invested, pay tax on purpose rather than by accident and end up with more after-tax wealth over the life of the account.

Which investments belong in a taxable account?

Asset location is the practice of putting each investment in the account where its tax treatment does the least damage. It’s different from asset allocation, which is the overall mix of stocks and bonds you hold. Location doesn’t change that mix. It changes which account each piece sits in.

Here’s why that matters. Some investments create taxable income every year whether you sell or not, through interest, non-qualified dividends or capital gains the fund manager realizes inside the fund. Others hold most of their value in the share price, so you pay tax only when you sell. In a retirement account, that annual income is either deferred (traditional) or never taxed again (Roth). In a taxable account, you pay on it every April.

Generally better in a taxable account	Generally better in a retirement account
Broad-market ETFs	Real estate investment trusts (REITs)
Index funds	Taxable bond funds and high-yield bond funds
Tax-managed funds	Private credit
Individual stocks with low turnover	Actively managed funds with high turnover
Municipal bond funds, when appropriate for your bracket	International funds that don’t pay qualified dividends

The funds in the left column tend to have low turnover, fewer taxable distributions and qualified dividends, which are taxed at long-term capital gains rates instead of ordinary income rates. Mutual funds deserve a specific mention. When other investors redeem shares or the manager sells appreciated holdings, the fund distributes those gains to everyone who owns it, so you can owe tax on a mutual fund in a year you sold nothing and the fund lost money.

These are general tendencies, and the right placement depends on what you own and how much room you have in each account. For example, if you’re a physician whose 403(b) is already full of bond funds, the taxable account may be the only place left for your stock exposure, and that’s a reasonable outcome. The point is to make the placement a decision instead of leaving it to whatever happened first.

What is cost basis, and why does it matter before you sell?

Cost basis is what you paid for your shares. Your unrealized gain is the difference between that and what the shares are worth today, and your tax lots are the batches of shares you bought at different times and prices. Those three pieces of information, together with your balance, tell you what a withdrawal will cost in tax.

Let’s break that down with an example.

Two investors each own $500,000 of the same ETF. One has a cost basis of $475,000 and the other has a cost basis of $150,000, so the first investor is sitting on $25,000 of unrealized gain and the second on $350,000. If each of them sells $100,000, the first realizes roughly $5,000 of taxable gain and the second realizes roughly $70,000. Their balances are identical, but the first investor pays tax on a small fraction of what the second does.

Which shares get sold first depends on the cost basis method you’ve elected at your custodian or through your adviser. There are three common ones:

• First in, first out (FIFO): Sells your oldest shares first. They usually qualify for long-term capital gains rates, but if you bought the fund 20 years ago, the gain on those shares is probably large.
• Average cost: Averages what you paid across all your shares. It’s simple to understand, and it removes your ability to choose which lots to sell.
• Specific identification (spec ID): Lets you choose the exact lots. If you’ve bought the same fund every month for 10 years, you can sell the lots with the highest cost basis and the smallest gain.

We prefer specific identification because it gives you control, year by year, over how much gain you realize. Average cost is the method we see most often, and it’s also the one that leaves you the least room to plan. Whichever method you use, review your unrealized gains by tax lot before making any major changes to your portfolio. That one step prevents most of the surprises people find at tax time.

How does tax-loss harvesting work?

Tax-loss harvesting means selling an investment for less than you paid for it in order to realize the loss. That loss offsets capital gains you’ve realized elsewhere, including gains you had no choice about, like a rebalance. If your losses exceed your gains, you can offset up to $3,000 of the remainder ($1,500 if you’re married filing separately) against ordinary income each year, and anything left carries forward indefinitely.

For example, say you realized $40,000 of gains during the year and harvested $30,000 of losses during a few volatile stretches. Your taxable gain is $10,000. Without the harvesting, you’d pay tax on the full $40,000.

Two rules keep this strategy working:

1. Stay invested. After you sell the losing position, buy a similar fund right away so you’re still in the market when it recovers.
2. Avoid a wash sale. The wash sale rule disallows the loss if you buy a substantially identical investment within 30 days before or after the sale. The replacement needs to be similar, but different.

Both are easier when you’ve chosen your replacement funds ahead of time. At SLP Wealth, we keep a pre-selected list of harvesting swaps for every model we manage, and we check client accounts daily against thresholds that trigger a harvest. You can do this on your own if you’re willing to watch the market closely and execute trades the day an opportunity appears. Losses tend to show up during corrections, often for only a few days or weeks, so harvesting is an ongoing job rather than something to do once in December. Each harvest and swap also resets your cost basis closer to today’s price, which keeps the unrealized gain in the account from growing unchecked.

How do you change your strategy without a large tax bill?

If you’re working with an adviser for the first time, moving into a model portfolio, consolidating accounts or diversifying away from a concentrated position (one holding that’s grown to dominate the account), your portfolio probably needs a different shape than it has now. Selling everything at once would realize years of gains in a single tax year.

A sell-only approach spreads that out. Here’s how it works:

• Mark the appreciated positions as sell-only and stop adding to them.
• Direct new contributions to the replacement investments.
• Send dividends to the new portfolio instead of reinvesting them in the funds you’re leaving.
• Sell the old positions gradually as opportunities arise, often when a harvested loss can offset the gain.

Over two or three years, the account reaches the new model, and you’ve chosen which tax year each piece of the gain lands in. Slower often produces a better tax outcome.

This is also a good time to look at automatic dividend reinvestment. It’s the default setting for most accounts, especially with mutual funds, and it can be how concentrated positions form in the first place: a fund that pays more dividends keeps buying more of itself, and over time your allocation drifts. Taking dividends in cash gives you money to rebalance, direct toward replacement investments, or spend, depending on your stage of life.

Should you donate appreciated shares instead of cash?

If charitable giving is already part of your plan, this is where taxes come into play. Donating appreciated shares you’ve held for more than a year is often more tax-efficient than donating cash:

• You avoid capital gains tax on the shares.
• You may receive a charitable deduction if you itemize.
• The charity receives the full market value.

A donor-advised fund separates the timing of your deduction from the timing of your gifts. You contribute appreciated shares, take the deduction in that year, invest the money tax-free inside the fund and grant it to charities on whatever schedule you choose. That makes a high-income year a natural time to fund one: a large bonus, a business sale, a stock option exercise or a Roth conversion. You can bunch several years of giving into the year the deduction is worth the most, and you can use the same move to get your most appreciated shares out of your portfolio.

Travis Hornsby, SLP Wealth’s CEO and partner, told me how he and his wife approached this. She pointed out that the tax savings meant they’d be giving less out of pocket than before. So they decided to increase their contributions by roughly the amount they saved on taxes, allowing the charities to receive more. If the tax savings make you feel like you’re giving less, you could take a similar approach.

What should a withdrawal plan include?

Every accumulation strategy eventually becomes a withdrawal strategy. Most investors spend years focused on contributing and investing, and they treat the withdrawal side as something to figure out later. By then, an account that’s been ignored for decades can hold massive unrealized gains, fewer options for diversifying and a larger tax bill than it needed to.

A distribution plan considers more than which lots to sell. You’ll also want to think through several tax considerations:

• Your current and future tax brackets. Consider your tax bracket today and the bracket you expect to be in during retirement.
• Capital gains taxes. Look at where long-term capital gains rates and the net investment income tax apply based on your income.
• Roth conversions. Each conversion increases your taxable income for that year, potentially pushing a large withdrawal over a tax threshold you would otherwise stay below.
• Required minimum distributions (RMDs). Future RMDs from your retirement accounts can increase your taxable income and affect your overall tax strategy.

Reviewing the account regularly, rather than waiting until retirement, gives you time to work through these questions before you need the money. Distribution planning deserves the same attention as investment planning.

When is paying the tax the right decision?

Here’s the reality: sometimes the best decision for your portfolio comes with a tax bill. Paying tax can be the right call when it improves diversification, reduces risk, simplifies your investments or brings the portfolio in line with your goals. The objective is higher after-tax wealth over time, and that’s different from the lowest possible tax bill in any single year. Don’t let the tax tail wag the investment dog.

If you’d like help with any of this, SLP Wealth’s investment management includes daily tax-loss harvesting checks and charitable giving planning as part of a comprehensive financial plan. We specialize in working with graduates who have student loan debt and want that plan to fit alongside building wealth. You can book a consultation to see whether it’s a fit.

Frequently asked questions