The uncertainty is over and investors now have all they need to know on how to position their portfolios for tax year 2011.
With both houses of Congress approving legislation to extend the Bush tax cuts—which were set to expire Dec. 31—and President Obama ready to sign it into law, tax rates on income brackets, capital gains and dividends will remain at 2010 levels.
In particular, year-end portfoliomoves can now be made with the knowledge that capital gains and dividend tax rates will remain at 15 percent.
Low Rates Prevail
With rates remaining favorably low, you’ll want to hold onto your stock market winners, says Christine Benz, director of personal finance for Chicago-based mutual fund tracker Morningstar.
“Defer the realization of capital gains as far into the future as you possibly can,” she says.
You might still want to harvest losses, or sell losing stocks to offset same-year capital gains (plus an additional $3,000 per year against ordinary income), before Dec. 31, to the extent it fits with your investment goals and diversification strategy.
Benz adds that any losses you might be able to harvest this year will be more valuable in future years when the tax rate for some income levels is likely to rise. At this point that is set to happen in 2013.
It’s worth noting, too, that there are no restrictions on buying back your high-flying stock if you wish to maintain your exposure.
The wash-sale rule, which prohibits taxpayers from claiming a loss on the sale of an investment and then repurchasing it within 30 days, applies only to stocks sold at a loss, says Mark Luscombe, principal tax analyst with CCH tax services firm in Riverwoods, Ill.
Those sold at a gain can be immediately repurchased without incurring a penalty.
“Some people mistakenly think that the wash-sale rule applies and it doesn’t,” says Luscombe. “You don’t face that issue on the gains side."
The tax deal also gives some breathing room for investors who have stocked up on dividend paying stocks .
“If you’re in a higher tax bracket in particular and you’ve been investing in such a way to take advantage of the lower dividend rate," Daniel D’Ordine, a certified financial planner with DDO Advisory Services in New York, you don't have to consider selling by year's end because the tax rate won't go up to 20 percent.
For the same reason, such investors may also want to acquire more.
Regardless of the outcome, however, D’Ordine and Benz agree that investors should not let the tax tail wag the investment dog. Investors this year more than ever should make investment decisions guide them.
“If you’ve gone through the rebalancing process and identified areas you want to trim back on it make sense from a tax standpoint to go ahead and do it,” says Benz. “But only make changes if the investment considerations line up with tax considerations.”