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This article is the first of a four part series that pertains to year-end financial planning. The articles will appear on consecutive Sundays over the next four weeks in “The Record” and include, in order, this article, “Year-End Tax Planning for Shareholders of Mutual Funds; “Year-End Charitable Bequest Planning” and “Investment Portfolio Re-Balancing for the New Year.” Following this series, we will provide readers with a Review of 2009 and our Investment Outlook for 2010.
One of the least time consuming and most profitable tasks one can assume during December as it pertains to their investment portfolio is to attempt to offset realized capital gains with capital losses in your portfolio. Calendar year came in like a bear and went out like a bull. In fact, through early March the major indices were down more than twenty percent. Couple this with the fact that 2008 was a horrible year for stocks and there is a good chance that investors some securities that have declined in market value relative to their purchase price. Assuming that the shares of the depreciated security are held in a non-qualified taxable account (not an IRA or pension plan), one might sell these shares and claim the loss on Schedule D of Federal Filing Form 1040.
Please note the following important IRS regulation that pertains to Capital Gains and Losses. If when comparing your realized (those securities sold or where the company has been purchased for cash by another company) gain with your realized loss, the net result is a loss, only up to $3,000 can be deducted from ordinary income. The balance can be carried forward, indefinitely.
An additional component to consider prior to realizing a capital gain or loss in your portfolio is whether the transaction would trigger a long-term versus short-term capital gain/loss. Long-term transactions are defined as those in which the underlying security has been held for one year or longer and are generally taxed at either zero percent for those taxpayers that are in the 10% to 15% marginal tax brackets or at 15% for those in the twenty-eight percent bracket. Short-term transactions, those which the security has been held for less than one year are taxed as ordinary income and subject to the same tax rate as your wages or dividend income. For most taxpayers, the rate is twenty-eight percent for the Federal Government. In both instances, for taxpayers in New York State, long-term and short-term capital gains are taxed as ordinary income.
One final consideration prior to executing a stock or bond trade for tax purposes would be to determine if, by executing this trade, a wash sale would result. A wash sale exists when the transaction results in a loss and a “substantially identical security” is purchased within thirty days. If this should occur, the tax loss created by the sale would not be deductible. Please note that should the wash sale result in a gain, the gain is taxable.
As an aside, never forget that it is always prudent to consider the impact of selling a stock upon your portfolio. Simply put, it is seldom wise to make a transaction solely for the purpose of saving money on your tax return!
A sale or sales of appreciating and/or depreciated securities represent only one tactic an investor can deploy when tax planning at year end. Furthermore, please note that this decision must be made in conjunction with and in full knowledge of the resulting impact on your other investments, such as mutual funds. Be certain to check with your tax advisor prior to making any year-end portfolio transactions!