Rate conversion uses tax-loss harvesting to offset higher-taxed short-term gains, then realizes replacement-asset gains after at least one year at lower long-term capital-gains rates. section 14.1.2
A $1,000 gain converted
With a 35% marginal federal rate and a 15% long-term capital-gains rate, $1,000 of short-term gains creates $350 of tax. Harvesting $1,000 of losses from an ETF and buying a similar replacement offsets the current bill. If the replacement later produces a $1,000 gain and is held for at least a year, tax falls to $150. section 14.1.2
Evaluate the trade-offs before relying on the conversion:
- Require at least a one-year holding period; otherwise the eventual gain remains short-term and the rate conversion does not occur. section 14.1.3
- Compare current and future tax rates, because a later higher rate can outweigh today’s tax reduction. section 14.1.3
- Expect the main benefit at the federal level; many states tax capital gains like ordinary income regardless of holding period. section 14.1.2
