Updated: May 3, 2013 12:14PM
Originally published: Jan. 6, 2002
Let me be among the first to remind you that it’s time to tally up those losses in your investment portfolio and consider some strategies to make use of them for tax purposes.
This is truly the silver lining in the ugly cloud of huge investor losses for 2001. But you have only 30 more trading days to take action, so now’s the time to start planning.
These strategies apply only to investment losses, or gains, taken outside your tax-sheltered retirement accounts. Those IRA and 401(k) accounts get no tax benefit; ultimately all the withdrawals will be treated as ordinary income.
The basic rules
First, a reminder of how the tax laws work when it comes to gains and losses from selling stocks or mutual funds. Gains and losses are offset against each other. Long-term gains on assets held for more than one year are taxed at a maximum 20 percent rate. Short term gains are taxed as ordinary income.
But if you balance out gains and losses and end up in the loss column, there is one benefit: Up to $3,000 of losses can be used to offset ordinary income. It’s as if you’d earned $3,000 less in salary. So you escape the taxes you would have paid on that income. If you’re in the 39 percent tax bracket, you’ll save about $1,200 in taxes by using that $3,000 stock loss to offset your income. And losses above that level can be carried forward to future years.
With losses abounding this year, you may find it worthwhile to “harvest” some of those losses --a new cash crop!--just to get the tax benefits. But what if you want to maintain your position in the stock in hopes it will rise again? Once you sell, you’ll have to wait 30 days to repurchase the stock or mutual fund, or you can’t use the tax loss.
But you could repurchase another similar stock or mutual fund to maintain your market position. You could immediately switch to another growth fund or tech stock to profit from any market rebound, yet still use your losses for tax purposes. Last year many investors learned the hard way that mutual funds are required to distribute the gains on stocks the fund manager sold at a profit. Each shareholder receives a proportionate share of the gains, which must be accounted for on individual tax returns--even if the investor hasn’t sold those fund shares.
But this year there is some small comfort for investors: With the market’s decline, there will be fewer gains to distribute. On the other hand, the funds cannot distribute losses for you to take against your ordinary income. Those losses remain in the fund, but can be carried forward to use at some future date. Thus, if you buy a mutual fund with large losses, you’re actually buying into a tax shelter if the market rebounds.
Some news on gains
It’s not surprising that this column has focused on losses this year. But what about gains? Long-term capital gains are prized because of their relatively low maximum tax rate of 20 percent. But this year the tax law introduced the possibility of even lower capital gains rates.
The maximum capital gains tax rate will drop to 18 percent on assets held for more than five years--if the holding period for the property starts in 2001 or later. So looking ahead, it may pay to hold assets you purchased this year for at least five years.
Even more useful, this year there’s a new 8 percent capital gains tax rate for those in the lowest 15 percent tax bracket. That 8 percent rate applies to property held for more than five years and sold in 2001 or later--no matter when it was purchased.
That creates an incredible opportunity for parents and grandparents to transfer long-held stock to a child or grandchild over age 14, who can then sell the stock and pay only an 8 percent capital gains tax on all those accumulated gains. That’s quite a break from the 20 percent rate the adults would pay.
Yes, the tax law is insanely complicated. I think they count on that in Washington, so we’ll miss some of the best tax deals--unless we pay for expensive professional advice. Some of these tax opportunities must be taken before yearend. That’s why it pays to pay attention now. And that’s The Savage Truth.
Terry Savage is a registered investment adviser and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail to email@example.com. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast.