Putting stock declines to use
It’s rarely wise to make a decision solely for tax reasons, but smart investors consider taxes prior to any move. Before the calendar rolls over to 2009, consider tax-loss harvesting to help lessen the pain of a difficult year in the stock market.
At a minimum, this is a year you should be able to avoid paying capital-gains taxes. If you sell a winner held for a year or less, the gain is typically considered short-term and subject to ordinary income-tax rates. In contrast, gains on securities held for more than a year are usually taxed at a lower rate of 15%. Investors in the two lowest ordinary income-tax brackets may qualify for a long-term tax rate of 0% on capital gains.
Many expect capital-gains rates to rise next year. President-elect Obama’s proposals included a boost in the top capital-gains rate to 20% for families with incomes above $250,000. So, to the extent you expect to have a net capital gain this year or next, you may want to realize the gain before year-end.
Remember, though, that you can offset losses against gains on a dollar-for-dollar basis, with no upper limit. For example, say in January you sold a stock for a gain of $2,000. More recently, you sold another stock for a $2,000 loss. Overall, your net gain is zero, so you pay no tax on the earlier gain.
Moreover, you can deduct up to $3,000 of net capital losses (or as much as $1,500 for those married and filing separately) each year from ordinary income, with any extra amounts carried over into future years.
If you sell to book a loss and plan to repurchase the shares later, be mindful of Internal Revenue Service wash-sale rules. A wash sale occurs if you sell at a loss and then buy the same security (or one nearly identical) within 30 days of the sale. The rule applies to trades 30 days before or after a sale — not just 30 days after. Investors who sell at a loss and don’t wait at least 31 days before repurchasing the stock can’t claim a loss on the sale.
Investors cannot record a loss if they dump a stock in a taxable account and repurchase it within 30 days in a tax-protected account. The table below lists eight Buy-rated stocks that are down sharply and represent potential candidates for selling now and repurchasing in 31 days. Given the wild market swings of recent months, you should not assume you will be able to buy back a stock at a similar or lower price.
With prices beaten down, investors might contemplate gifting stock to family members because they can give away more shares tax-free. Individuals can give an unlimited number of $12,000 gifts without paying gift tax. For example, based on Transocean’s ($62; NYSE: RIG) recent stock price, investors could gift roughly 190 shares ($12,000 divided by $62), compared to about 95 shares a year ago. A stock’s cost basis is transferred to the recipient, though on gifts above $12,000 a portion of the gift tax is factored into the new cost basis. Before gifting a stock, consult a tax professional.
Fund tax moves
While most mutual funds are in the red this year, many will still make distributions to shareholders. Mutual funds typically distribute capital gains around the end of each year, and the payments are taxable if the investments are held in a taxable account — even if you reinvest. To find out whether your fund is paying a capital gain, call the fund.
If you are considering a fund for which a large distribution looms, buy another fund or wait until after the record date. Otherwise, you are simply buying a dividend, exposing yourself to taxes on the distribution but gaining no added value for the shares.
Fund investors can also use wash-sale rules to manage their taxes, selling a fund ahead of a distribution and waiting 31 days to repurchase the same fund. Another good move is to sell a fund to take a loss and buy a similar (but not quite identical) fund the same day. This strategy allows you to upgrade your fund, book the tax benefit, and maintain your asset allocation.