For years there were only two main capital gains rates: 20% (and then 15% for the seven years prior to 2013) for moderately affluent and high-net-worth investors; and then a lesser rate of 10%, 5%, and zero for the bottom tax brackets.

That all changed last year as capital gains rates got complicated for moderately affluent and high-net-worth investors. With the introduction of a 3.8% Medicare surtax on investment income including capital gains and a new top capital gains rate of 20%, there are now four capital gains rates: zero, 15%, 18.3% (including the Medicare surtax), and 23.3% (including the surtax).

With four tax rates to worry about, the traditional strategy of harvesting tax losses while keeping winners should not necessarily be the default response by advisors who are charged with protecting their clients’ assets.

When it was all the same rate, timing was not as important. Investors could either take the gain or loss right away or in the future, but the tax consequences were the same either way. Multiple rates create a distinct problem, however, in that as an investor’s unrealized gains grow over time, so does the size of their deferred tax liability. This can ultimately push an investor into a higher tax bracket, causing shrinkage in their estate.

The “catch 22” is that traditional capital gains harvesting of losses (and subsequent buy-back after the 30-day wash rule waiting period) brings down the cost basis of the asset, thus setting up larger gains in the future. Done often enough, upper income clients could find themselves in a higher tax bracket when the gains are harvested.

Michael Kitces, the well-known research director at Pinnacle Advisory Group in Maryland, illustrates:

“Assume an investment was purchased for $100,000, but is now worth only $90,000 due to a significant market decline. The investor harvests the $10,000 capital loss, which generates a $10,000 loss deduction resulting in $1,500 of current tax savings at a 15% tax rate. However, after harvesting the loss, the investment only has a cost basis of $90,000, which means if the investment ever recovers to $100,000 again, there will be a $10,000 gain, resulting in a $1,500 tax liability at the same 15% tax rate. Thus, in the end the $1,500 tax savings now is offset by a $1,500 tax increase in the future, and the net result is $0 of tax savings (which makes sense, since the investment started at $100,000 and ended at $100,000).”

All of this is not to say that harvesting capital losses is a bad idea. It simply means that doing so is not necessarily always a good one. It is also serves as another reason to talk with a Financial Advisor before the end of the year to devise a plan to minimize taxes on your investments.