We know you may be thinking about year-end; and your tax planning should begin well before December 31. In fact, you may want to act before the end of November. Some shrewd moves then might pay off next April, when your 2006 tax returns are due. When you file that tax return, you’ll net all your capital gains and losses for 2006. You’ll be able to deduct up to $3,000 worth of net capital losses while excess losses can be carried forward to future years until they are completely used up. Tally your trades Your first step in year-end securities trading, then, is to calculate your capital gains and losses so far this year. Don’t forget to include capital gains distributions from your mutual funds. Even if you reinvested those distributions, they’ll count as taxable gains on your tax return. Suppose you discover that you have $10,000 worth of net gains so far this year. For tax purposes, your best tactic is to take $13,000 worth of losses by December 31, to give you $3,000 net loss for the year, which you can deduct against ordinary income. Instead of owing $1,500 in tax on your $10,000 gain (assuming a 15% capital gain rate), you’ll save up to $1,050 on a $3,000 loss (at ordinary income rates as high as 35%). The situation is a bit different if you discover you have a net loss greater than $3,000 for the year-to-date. If so, you can take capital gains to bring your loss down to $3,000. Otherwise, you’ll wind up with an excess loss that can’t be used immediatelyFor example, if you have a $20,000 capital loss for the year so far, you can take $17,000 worth of capital gains and receive tax-free cash. Be wary of wash sales Whether you take losses or gains at year-end, you will disrupt your portfolio. Instead of holding stocks or bonds or mutual funds, you’ll hold cash. What’s more, if you take a loss and reinvest in the same securities within 30 days, you will not be allowed to deduct the capital losses, under the “wash-sale” rules. How can you keep your investment plan intact yet avoid a wash sale? There are three options: 1. You can wait for 31 days, then repurchase the same security. Here, your risk is that the stock or fund will shoot up in price during those 31 days. If you can bear that risk and you still want to own this security, this can be a good choice. 2. If you want to reinvest sooner than 31 days, you can buy similar but not identical securities. If you sell one large-company growth stock fund, for example, you immediately can buy another large-company growth stock fund. If you have sold one auto company, you can buy the stock of another car maker. The net effect may be to realize sizable tax savings while making only minor changes in your portfolio, as long as you are confident that your replacement security will perform in much the same manner as the one you sold. 3. You can “double up” by buying an equivalent amount of the securities now trading at a loss. Then you can sell your original holding 31 days later. Double play Say you invested $25,000 in a growth fund that has failed to perform so your holding is now worth the only $20,000. However, you still like that fund and you think it’s even a better buy now, at a lower price. You can buy another $20,000 worth of shares in that fund. After 31 days, you can sell your original holding. You won’t run into the wash-sale rules and you won’t run the risk that the fund’s price will go up while you’re on the sidelines. The catch? Doubling up is not truly a year-end maneuver. You should buy the second lot by November 29 if you want to sell the original lot at the end of December and take a tax loss for 2006. Immediate gratification In addition, you should be aware that the wash-sale rules do not apply to the sale and repurchase of appreciated securities. Therefore, if you take year-end gains to soak up some excess capital losses, as described above, you can reinvest in the same securities right away, without having to wait 31 days. This will result in a higher basis in the repurchased securities and reduce the tax when you eventually close out your position. |