End Of The Year Tax Strategies You Can’t Miss

At this point, tax rates are scheduled to rise in 2011; no moves to reinstate tax cuts are going to take place prior to the election. Taxpayers with unrealized capital gains or losses need to start planning now for possible asset sales.

Investment decisions should never be made exclusively on the basis of tax strategy, but when there are various options available consistent with good investment strategy, it makes sense to pay attention to the consequences of asset sales in taxable accounts.

The maximum long-term capital gains tax rate of 15% is scheduled to “sunset” at the end of 2010 and return to 20% (18% for assets held for more than five years).  Short-term capital gains are taxed at the same rate as ordinary income, with a maximum rate of 35% in 2010 (expected to rise to 39.6% next year).

Making Use of Long-Term Capital Losses
When the sale of an asset produces long-term capital losses, tax rules require that these must first be used to offset long-term capital gains; if any losses remain, they may offset short-term capital gains.  If there is still a net capital loss after short-term gains are offset, the loss can be used to offset ordinary income, but there is a limit: up to $3,000/year in net capital losses can be used as a deduction against ordinary income, reducing the taxpayer’s adjusted gross income (AGI).

Thus, long-term capital losses have the greatest value when they can be applied to reduce one’s short-term capital gains and/or ordinary income because both are taxed at a higher rate than long-term capital gains.  Assuming that a sale makes sense from an investment standpoint, it could be desirable to realize long-term capital losses in a different year from the one in which long-term capital gains are realized.  This takes full advantage of the lower tax rate on long-term capital gains and permits the losses to reduce income that would otherwise be taxed at higher rates.

As a further consideration, if a taxpayer expects to realize capital losses next year that exceed the $3,000 threshold, he might consider the possibility of shifting some of those losses into 2010 to reduce some ordinary income in both years.

Should You Sell Appreciated Assets in Anticipation of Tax Rate Changes?
Here again, the decision should be made primarily on the basis of investment planning, not tax planning.  But if you have significant gains in taxable assets and no losses to offset them – a nice problem to have – it makes sense to identify which assets you think ought to be sold on the basis of your investment strategy.  If this year’s “lame duck” Congress reaches a decision on 2011 tax rates, you’ll be prepared to act quickly in response.  If the capital gains tax rate increases remain on the books, for example, it could make sense to sell your appreciated assets before yearend to lock in a 15% maximum rate.

About the author

Thomas Fisher, CFP®

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