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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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