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Year End Tax Planning (Part 2)

     What strategies can you employ to make your taxes more palatable? As we discussed last week, first get together all your transaction information and pair up the pieces of each position. Second, quickly prepare a tax return to see where you're likely to end up for the year and see in advance of the end of the year any changes you need to implement before December 31. Third, schedule an visit with your tax advisor over the next couple of weeks to discuss action you need to take before the end of the year to put yourself in the best possible tax position. What's next? You need to get a handle on your total gains and losses for the year. How long have you held each position? The critical holding period is twelve months. Gains on stocks held longer than that are taxed at a 20% tax rate, gains held less than 12 months are taxed at 36%. Short-term losses are used to offset short-term gains, and long-term losses are used to offset long-term gains. If your losses exceed your gains you can use up to $3,000 in losses to offset ordinary income. If you still have losses after that, you can use the losses to offset gains or income over the next seven years.

    There are a number of considerations when selling stock to take a loss. First keep in mind you can't go up to the last day of the year and sell a stock to book a loss. To be safe you need to keep in mind brokerage firms give transactions three days to clear, so give yourself your firm's clearing period. A more important trap to avoid is the 30-day "Wash Sale" rule. If you sell a stock to book a loss and then re-buy the same stock within 30 days you don't get to book the loss, rather the cost basis of the new purchase is added to the old basis. Buying a call option on a stock you've sold is tantamount to re-buying the stock, so be careful. The problem with the 30-day wash rule for the investor is it keeps you out of a stock for 30 days that you may want to own long-term. Just because you are booking a loss in a stock doesn't mean you don't think that it is very attractively priced at current levels. It just means you're trying to garner the best possible tax position. And if the stock climbs sharply during the 30 days you can't own it you'll really be kicking yourself. One strategy that allows you to work around this is to buy shares in a similar stock. Most stocks move in tandem within the same sector. Healthcare rises as a group and falls as a group. Chip stocks rise and fall as a group. If you are selling Intel to take a tax loss, buy AMD. You can hold the substitute long-term or swap back into the original stock 31 days later. If you feel your portfolio hasn't been as diversified as it needs to be, you can use this opportunity to buy other stocks within an industry or within a different industry. There are a few strategies floating around that may bite you in the wallet if you are audited, and should be avoided. Some say you can sell a stock in a taxable account to book the loss and then buy it right back in an IRA or another non-taxable account. In theory this would work because a trustee handles the IRA, but it's likely a court test of this maneuver will find you the loser. Selling the losing stock and having a relative or dependent buy it would again be questionable. These are helpful suggestions, but we recommend you check with your tax advisor before taking any action.

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