Tax planning depends on your circumstances
As the summer draws to a close, it’s time to size up stocks in your portfolio that may be ripe for selling this year, especially when you factor in the tax consequences. It’s an annual ritual known as “harvesting” capital losses. However, due to recent tax law changes, you may be inclined to reap different tax benefits.
Basic rules: The capital gains you recognize during the year from sales of securities can be offset by capital losses on sales of securities, and vice versa. In addition, if you have an overall loss at the end of the year, you can offset up to $3,000 of highly taxed ordinary income before carrying over any remainder to the next year. This capital loss carryover can offset capital gains and up to $3,000 of ordinary income in 2015.
This is traditionally the time when investors start perusing their portfolios to find securities that can be sold at a loss to absorb capital gains recognized earlier in the year. The harvesting loss strategy is especially valuable for offsetting short-term gains (i.e., gains from sales of property owned for a year or less) that are taxed at ordinary income tax rates. For 2014, the top ordinary income tax rate is 39.6%, plus upper-income investors may also be liable for a 3.8% Medicare surtax on capital gains. Thus, it may still behoove you to harvest capital losses.
On the other hand, long-term capital gains (i.e., gains from sale of property held more than one year) are in line for preferential tax treatment. Currently, the maximum tax rate is 15% for most taxpayers. (Investors in the two lowest ordinary income tax brackets can benefit from a 0% rate.) For taxpayers in the top 39.6% bracket, the maximum tax rate on long-term capital gain is increased to 20%.
Therefore, the optimal tax strategy for 2014 varies for taxpayers, depending on such factors as your gains and losses thus far, your current tax rate, and your expected tax rate for next year. As an example, if you expect to be in the 35% tax bracket this year and then jump to the 39.6% tax bracket next year, you might realize more long-term capital gains this year to benefit from the 15% tax rate. Conversely, if the situation is reversed—you anticipate that you will reach the top 39.6% rate this year and slide back into the 35% bracket next year—you might decide to postpone gains and/or harvest losses to offset this year’s gains.
In addition, consider the potential impact of the “wash sale rule” that prevents you from claiming a tax loss from the sale of securities if you acquire substantially identical securities within 30 days of the sale. Give yourself plenty of time to maneuver around this rule if you are trying to harvest losses.
For example, suppose you are holding a stock showing a $5,000 loss. You would like to realize the loss this year but believe the stock will rebound. One idea is to sell the shares now and then wait at least 31 days to buy back the same stock. Alternatively, you might “double up” now and wait 31 days to sell the shares you originally owned.
Final words: Above all, it is important to stay flexible enough to adjust your investment strategies to meet your changing needs and objectives. Consult your financial and tax advisers concerning harvesting of capital losses or gains between now and the end of the year.