A tax heuristic is a practical rule for choosing trades or tax lots when rebalancing. Instead of always returning exactly to target weights, it can leave small deviations when selling appreciated assets would create a large tax bill. section 13.2.3
Useful tax-lot rules include:
- Prefer realizing long-term gains over equal-sized short-term gains because the applicable tax rate is lower. section 13.2.3
- Among short-term gains, prefer selling a newer lot when an older lot is close to becoming long-term. section 13.2.3
- For losses, prefer realizing a lot that is about to become long-term, because the higher short-term rate increases the tax benefit. section 13.2.3
A simple lot-selection rule
Suppose 35 shares must be sold from four lots. Calculate each lot’s effective rate as percentage gain multiplied by its applicable tax rate, sort lots from lowest to highest, and sell from that order until the required quantity is reached.
