Recent years of strong stock market gains, combined with volatility in 2026, have left many investors with portfolios that no longer match their intended asset allocation. If you haven’t rebalanced in a while, now may be the time — but it’s essential to consider the tax impact. With smart planning, you can reduce the tax cost of rebalancing.
What Is Rebalancing?
When you first built your portfolio, you considered factors like performance goals, risk tolerance, and age to determine an allocation across asset classes (stocks, bonds, money market funds) and subcategories (large-cap vs. small-cap stocks, municipal vs. Treasury bonds).
Over time, certain investments outperform others, causing your portfolio to drift away from its original balance. This can increase risk and misalign your portfolio with your goals.
Rebalancing means selling investments that have become overweighted — often appreciated stocks or mutual funds — and reinvesting in underweighted areas. However, selling appreciated assets in taxable accounts triggers capital gains taxes unless the assets are held in tax-advantaged accounts like IRAs or 401(k)s.
Taxable Brokerage Accounts
Capital gains and losses in taxable accounts are netted against each other when you file your tax return.
- Long-term gains (assets held over one year) are taxed at 0%, 15%, or 20%, depending on income. Some investors may also owe the 3.8% Net Investment Income Tax (NIIT), plus state taxes.
- Short-term gains (assets held one year or less) are taxed at ordinary income rates, up to 37%, plus NIIT and possible state taxes.
- Net capital losses can offset up to $3,000 of ordinary income ($1,500 if married filing separately), with excess losses carried forward.
Tax-Advantaged Retirement Accounts
Selling assets inside retirement accounts affects only the account balance, not current taxes.
- Traditional accounts (non-Roth): Withdrawals are taxed as ordinary income, and state taxes may apply.
- Roth accounts: Qualified withdrawals are generally tax-free, including gains.
Tax-Smart Rebalancing Strategies
If you hold both taxable and retirement accounts, consider them together when rebalancing. For example, selling appreciated stocks in a retirement account avoids current-year taxes.
If selling in taxable accounts is unavoidable, look for opportunities to offset gains with losses. Remember, losses inside retirement accounts don’t reduce current-year taxes.
When gains are inevitable, prioritize selling assets held longer than one year to benefit from lower long-term capital gains rates.
Also, think strategically about where to hold new investments:
- High-growth assets often fit best in Roth accounts, where gains can be withdrawn tax-free.
- Frequent trading belongs in tax-advantaged accounts to avoid high short-term tax rates.
Beyond Current-Year Taxes
While taxes matter, don’t let them dominate your investment decisions. Rebalancing should also reflect your long-term goals, risk tolerance, time horizon, fees, and overall strategy. Taxes are one piece of the puzzle, not the whole picture.