Tax-Efficient Investing 101

A collection of strategies to help business owners keep more of their wealth.

Key numbers

Tax-efficient investing isn't about exotic strategies. It's mostly about a few well-understood principles that most people don't apply consistently.

Holding period is the most important variable

Short-term gains — investments held less than a year — are taxed as ordinary income. At roughly 54%, that's a steep rate. Long-term gains — held more than a year — qualify for preferential rates, roughly 37%. That's 17 percentage points for holding an investment one year and one day instead of eleven months. Before selling anything at a gain, check the date.

Buy and hold defers the tax indefinitely

You don't owe capital gains tax on an investment until you sell it. Unrealized gains are tax-free. An investment that doubles in value over ten years has generated no taxable event if you haven't sold. This is the single most powerful form of tax deferral available in a taxable account — and it costs nothing.

Low-turnover funds minimize forced taxable events

When a fund manager sells holdings inside the fund to rebalance or rotate, you share in the capital gains tax on those trades even if you didn't sell your shares. Actively managed funds with 50–100% annual turnover generate this drag constantly. A broad market index fund with 3–5% annual turnover generates almost none. For taxable accounts, this difference compounds significantly over time.

Qualified dividends are taxed at capital gains rates

Not all dividends are equal. Qualified dividends from U.S. corporations and many foreign corporations are taxed at the lower long-term capital gains rate. Ordinary dividends — including interest from bonds and dividends from REITs — are taxed as ordinary income. At a 54% ordinary rate, this distinction matters a lot.

Tax-loss harvesting converts losses into tax savings

When an investment drops below your purchase price, you can sell it, realize the loss, and use that loss to offset capital gains or up to $3,000 of ordinary income per year. Unused losses carry forward indefinitely. The key is to stay invested — you can sell a fund at a loss and immediately buy a similar but not “substantially identical” fund to maintain your market exposure. If you repurchase the same fund within 30 days (before or after the sale), the wash-sale rule disallows the loss.

Running a $1M+ taxable portfolio, there are real losses to harvest in most market environments. At these rates, a $50,000 loss offset against a $50,000 gain saves roughly $18,500 in taxes. That's not a rounding error.

Put these five principles together — hold for more than a year, don't sell what's working, use index funds in taxable accounts, favor qualified dividends, and harvest losses when available — and you've captured most of what tax-efficient investing can do. The advanced strategies in the next few pages build on this foundation; they don't replace it.