Investors, Make Your Tax-Related Moves Now

Investors, make your tax-related moves now

As you consider year-end strategies for reducing your tax bill, look to your investment portfolio — it’s an area that’s often ripe for examination. Techniques such as harvesting capital losses are highly effective and can be implemented quickly.

While you review the strategies that follow, keep in mind that your investment decisions should never be driven by tax considerations alone. But if buying or selling a security makes financial sense, it pays to take taxes into account when timing your investment moves.

Harvesting gains — and losses

As you watch the value of your investments go up and down, remember that these fluctuations exist only on paper. You don’t make or lose money until you “realize” these gains or losses by selling an investment. If you’ve realized net capital gains this year, they’ll be taxed at rates as high as 23.8% for long-term gains (on assets held more than a year) and 40.8% for short-term gains (including the 3.8% net investment income tax).

One way to ease your tax burden is to “harvest” capital losses — that is, sell investments that have declined in value and use the losses to offset your gains. And if your losses exceed your gains, you can deduct up to $3,000 of your net capital loss from your ordinary income, such as wages and interest. Plus, the losses that remain are “carried forward” for life.

On the other hand, if you’ve realized a net capital loss this year, it may make sense to harvest long-term gains. This allows you to sell one or more investments that have appreciated in value without triggering capital gains taxes. One thing you should avoid, though, is offsetting all your net loss. If possible, consider preserving up to $3,000 in net loss to reduce your ordinary income.

Timing it right

If you plan to sell an investment at a loss, consider the timing carefully. In some cases, you’re better off selling a short-term rather than long-term asset. Why? Because in calculating your net capital gain or loss for the year, the first step is to offset short-term gains against short-term losses and long-term gains against long-term losses.

Suppose, for example, that you’ve realized $25,000 in short-term gain and $25,000 in long-term gain this year, and you also own stock, purchased December 15, 2018, whose value has declined by $25,000. If you sell the stock on December 31, 2019, your $25,000 long-term loss will offset your long-term gain, leaving you with a $25,000 short-term gain taxable at ordinary-income rates.

However, if you sell the stock on December 1, you’ll generate a short-term loss that erases your short-term gain. And that leaves you with a $25,000 long-term gain taxed at more favorable rates.

Having your cake and eating it, too

Selling an investment at a loss may be a good tax strategy, but what if you’re confident that the investment will rebound in the coming years? It may be possible to harvest the loss for tax purposes and then buy back the investment to keep your portfolio intact.

It’s critical to plan carefully, however, to avoid running afoul of the “wash sale” rule. Under that rule, when you sell a stock or other security at a loss, you can’t take a current deduction if you purchase a substantially identical security within 30 days before or after the sale. So, to take advantage of this strategy, you must wait at least 31 days before you buy back the investment. This can be risky, because an unexpected price increase could wipe out the tax benefits. There are, however, other techniques you can use to mitigate the risk. (See “Clean up your wash sales.”)

Clean up your wash sales

As this article explains, it’s possible to sell investments at a loss to reduce your tax bill and then buy them back to preserve the integrity of your portfolio. But the wash sale rule prevents you from buying substantially identical securities within 30 days before or after the sale. If you sell an investment and wait 31 days, there’s a risk the price will go up before you buy it back, defeating the purpose of this strategy.

Fortunately, there are techniques you can use to mitigate the risk. For example, you can replace the original investment with one that is similar, but not identical. This could be stock from another company in the same industry. The wash sale rule wouldn’t apply, so you could make the purchase immediately.

If you can afford it, another strategy is to double up on your investment. In other words, buy the same number of shares of the identical investment, wait 31 days and sell the original investment. If the price is the same or less, you can deduct the loss without changing your portfolio’s makeup. If the price goes up, the additional gain makes up for the lost deduction.

A balanced approach

Your tax and investment advisors can help you develop a year-end plan that balances tax savings with sound investment strategies.

For more information on our services, please visit our tax services page or our general services page. If you have any questions, please contact one of our tax professionals at (973) 298-8500.

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