capital gains and losses
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How to Make Tax Hay Out of Securities Transactions

Oct 27th 2016
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You don’t have to be a farmer to reap the tax benefits of “harvesting” capital gains and losses. This time-tested technique, which often involves securities transactions, still presents unique tax-saving opportunities for investors.

Start with the basic premise that sales of capital assets, such as securities, are taxed under a separate set of rules. Capital gains and losses incurred during the year are used to offset each other. While gains may be taxed at favorable rates, an excess loss can be used to offset up to $3,000 of ordinary income before any remainder is carried over to next year.

The maximum tax rate on net long-term capital gain on sales of assets held longer than one year is only 15 percent for most taxpayers and 20 percent for those in the top ordinary income bracket of 39.6 percent.

But a short-term gain is taxed at ordinary income rates. Even better, for taxpayers in the two lowest tax brackets of 10 percent and 15 percent, the rate is reduced to zero percent. For instance, your child in college might benefit from this virtually unprecedented tax break.

Typically, your year-end strategy will be dictated by a current analysis of your portfolio.

If you’re showing a net gain, you may harvest losses through securities sales. The losses can offset the prior gains, plus up to $3,000 of ordinary income. This is especially advantageous if you have already realized highly taxed short-term gains.

If you’re showing a net loss, you may harvest gains through securities sales. The gains are effectively absorbed by the prior losses. This is especially advantageous if you then realize additional long-term gains.

Keep in mind that the zero percent rate for long-term capital gains is also available to investors traditionally in the higher tax brackets to the extent the income falls into the two lowest tax brackets of 10 percent and 15 percent. This could occur in a low-income year.

Don’t ignore other tax considerations. Remember that a 3.8 percent surtax may apply to “net investment income,” including capital gains realized during the year. Also, investors should be wary of the potential impact of the “wash-sale rule.” This rule prohibits you from claiming a current loss if you acquire substantially identical securities within 30 days of a sale of securities.

Fortunately, the wash-sale rule can easily be avoided. For one thing, you can simply wait more than 30 days before buying back the same or similar securities. Alternatively, you can “double up” now by buying more securities and then waiting more than 30 days to sell the original shares.

Taxes aren’t the be-all and end-all in your investment decisions, but they can provide a decisive edge. Advise your clients accordingly.


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