Year End Investing Tax Tips 2009 - Special Report

Capital Gains: Take The Money And Run

Shelly K. Schwartz, |Special to

Leftover losses from 2008 and the threat of higher taxes in the coming year could inspire more investors to harvest higher-than-usual capital gains before the end of the 2009.

Capital Gains

Indeed, seasoned investors have been taking advantage of this rule to minimize taxes on investment income for years, selling losing assets such as stocks and bonds to offset the profits of other ones, but the enormous losses of the stock market meltdown of 2008-2009 followed by an eight-month rally has created an unusual situation.

“Last year [2008] was the first in many where losses were prevalent enough that tax loss harvesting was common,” says Bob Adams, a certified financial planner with Armstrong Retirement Planning in Cupertino, Calif. “Those who did so now have the opportunity to balance gains this year.”

If, after realizing all your gains and losses for the year, you end up with a net loss you can use up to $3,000 to offset earned (or ordinary) income. Any loss in excess of that amount can be “carried forward” to offset future capital gains.

Needless to say, there are more than a few investors sitting on such losses today, leftovers from the bear market, which can be applied toward current-year gains.

At the same time, of course, most investors are keenly aware that the Obama administration has proposed raising the capital gains tax rate for high income individuals from 15 percent to at least 20 percent—some believe higher—by 2011, which may prompt some to sell appreciated stocks while rates remain low, says Mark Luscombe, principal tax analyst for CCH tax services firm in Riverwoods, Ill.

“That may cause some people to want to realize gains in anticipation,” he says. “From a tax point of view the ideal is to have a net capital loss for the year of $3,000 because that’s what you can offset against other income.”

The threat of higher capital gains taxes in the coming years, of course, might also have the opposite effect, prompting some investors to dump some of their dogs and bank those losses this year for use against gains in the higher tax rate years ahead.

“If you have a [paper] loss in a current investment you might want to realize that loss this year in order to balance it against gains in future years,” says Adams, who notes that tax loss harvesting can be done any time during the year, not just at year-end.

The capital gains equation may be all the more important for those people who expect their ordinary income (wages or salary) to be flat or lower in the years ahead and/or are facing the prospect of a higher income tax rate. 

Making Losses Count

Though capital-gain-and-loss harvesting is fairly common tax management, it is also complex, requiring careful planning and above all else, a willingness to sell stocks, which for some investors is not as simple as it seems

After all, tax laws only recognize real gains and losses on assets that are actually sold during the year. Paper gains and losses don’t count.

“You have to know the rules, know the tax status of your investments and be willing to sell,” says Luscombe.

Many investors, for instance, are reluctant to admit they made a mistake, so instead of selling a losing stock they hold onto to it in the hope of breaking even or notching a profit in the future.

“They also may be reluctant to sell a winning stock, even if selling earlier rather than later means they can minimize taxes on their gains,” says Luscombe.

“They often have to choose between actions that produce tax advantages and those that maximize investment gains.”

The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, says CCH, since the IRS requires taxpayers to first balance short-term gains with short-term losses and long-term ones with long-term losses.

(Investments held for 12 months or less are considered short-term and are taxed as ordinary income, which for investors in the upper tax brackets is considerably higher than the capital gains rate.

Assets held for longer than a year are treated as long-term gains and taxed at 15 percent for taxpayers in the 25 percent and higher brackets. Those in the 15- percent or 10-percent brackets are generally taxed at 0 percent for long-term gains.

If you bought various amounts of shares of a given stock at various prices over a period of time, CCH notes you may have both long-term and short-term gains, depending on which lots of shares are sold.

To maximize your tax advantage, CCH notes you’ll have to instruct your broker which shares you want sold.

If you have real losses this year or you’ve carried some forward from a prior year, you should consider two options, says Luscombe.

One is to realize gains to the extent that they can be offset by losses.

The other is to hold on to the short-term assets until they qualify for long-term treatment.

Though tax-efficiency is central to successful investing Luscombe warns investment, not tax considerations, should come first.

“Don’t let the tax tail wag the investment dog. Look over your portfolio from an investor’s point of view and see what you think you want to hold onto or sell,” he says. “If there are assets you want to sell that are currently at a gain, and you have some losses it may make some sense to do that before year-end to absorb some of those losses.”

And in case you think you can have it both ways, the IRS is way ahead of you on that.

If you’re planning to dump a dog for tax purposes, but expect it to rebound in the coming months, be careful about timing the repurchase of that stock or fund.

The so-called Wash Sale Rule bars an individual from claiming a tax-deductible loss on a security if he repurchases the same or a “substantially identical” asset within 30 days of the sale.