You’re going to hear a lot about “harvesting” capital gains and losses later this year. It’s all tied into the scheduled demise of the Bush tax cuts.
Strategy: Line up the capital gains and losses you expect to recognize. Depending on your situation, you may want to harvest losses soon to offset gains or vice versa.
It’s especially important to realize the “right kind” of gain or loss in 2012.
Here’s the whole story: An investor in securities and other capital assets “nets” long-term gains and losses and short-term gains and losses incurred during the year. A gain or loss is long-term if you’ve held the asset for longer than one year (see box below). Traditionally, if you’re currently showing a net gain for the year, you might try to harvest losses to offset those gains before the close of the year. Conversely, you may harvest gains that will be sheltered by prior losses.
But it’s complicated this year by three key changes slated to take effect in 2013.
1. The maximum tax rate for net long-term capital gain will increase from 15% to 20% (from 0% to 10% for low-income investors).
2. Ordinarywill be adjusted upward. The top 33% and 35% rates will jump to 36% and 39.6%, respectively.
3. A 3.8% Medicare surtax will apply to the lesser of net investment income for the year or the amount by which modified adjusted gross income (MAGI) exceeds $250,000 ($200,000 for single filers). This provision was included in the 2010 health care law.
You could face an effective tax rate as high as 43.4% next year on ordinary income from short-term gains!
There’s an extra incentive to trigger capital gains in 2012 to take advantage of the current favorable tax rates. Therefore, you might go against the grain this year by harvesting gains instead of losses, assuming it suits your purposes.
The long and the short of it
In any event, you can save yourself valuable tax dollars by observing a couple of basic principles.
1. Use short-term losses to offset short-term gains. You don’t want to waste short-term losses by offsetting long-term gains when long-term gains are taxed at a maximum rate of only 15% in 2012. However, if you’re already showing higher-taxed short-term gains, you might take down some short-term losses to offset them.
2. Use long-term losses to offset short-term gains. On the other hand, if you already have a bushel of short-term gains, you might take down some long-term losses. Don’t waste long-term losses that would offset long-term gains—again, long-term gains are taxed at only 15% this year.
Tip: Finally, don’t ignore the “wash sale rule,” which prevents you from deducting a loss on a securities sale if you acquire substantially identical securities within 30 days before or after the loss sale.