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Time securities sales for tax payoffs: year-end planning

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in Centerpiece,Small Business Tax,Small Business Tax Deduction Strategies

IRS websiteIt’s a different story this year-end for investors in securities. Due to pending changes in tax rates for 2013, the usual emphasis on harvesting capital losses has shifted to realizing capital gains.

Strategy: Don’t forget how the “netting rules” work (see box below). Depending on your situation, it may be advantageous to take down some, but not all, of your capital gains in 2012. Similarly, while you might realize certain capital losses this year, you may prefer to postpone others to next year.

And, of course, taxes aren’t the “be-all and end-all.” You should weigh all the relevant investment factors, including the future prospects for the securities, in your decisions to buy, sell or hold.

Background: Barring new legislation, the current six-bracket tax rate structure with a top rate of 35% will be replaced by a five-bracket rate structure with a top rate of 39.6%, beginning in 2013. Also, the tax rate on net long-term capital gains (i.e., for capital assets held longer than one year) for investors who are outside the lowest two brackets jumps from to 15% to 20% next year. Finally, the new 3.8% Medicare surtax may apply to your net investment income.

Worst-case scenario: The top tax rate on your ordinary income, including short-term capital gains, can effectively reach a whopping 43.4% in 2013 (39.6% + 3.8%)!

As things stand now, the basic strategy for higher-income investors is to realize capital gains in 2012, when gains will be taxed at lower rates than they will in 2013. At the same time, you should postpone losses to 2013, when they can be used to offset capital gains and up to $3,000 of ordinary income that will be taxed at higher rates.

Here are five examples showing how this might play out for taxpayers in the highest tax bracket (absent any transactional costs).  

Example 1: You are currently showing a net long-term capital loss of $10,000 for 2012. At year-end, you can sell stock for a long-term capital gain of $6,000. Best tax idea: Sell the stock. The capital gain will be completely absorbed by the existing loss. Then you can use $3,000 of the remaining $4,000 loss to offset ordinary income this year. Finally, you can carry over the remaining $1,000 loss to 2013.

Example 2: You are currently showing a net long-term capital gain of $3,000 in 2012. At year-end, you can sell stock for a long-term capital gain of $10,000. Best tax idea: Sell the stock. The tax on the $10,000 will be only $1,500 (15% of $10,000) as opposed to $2,000 (20% of $10,000) if you wait to sell the stock in 2013.

Example 3: You are showing a net long-term gain of $10,000 in 2012. At year-end, you can sell stock for a long-term loss of $3,000. Best tax idea: Hold the loser stock. If you sell in 2012, the loss will offset $3,000 of a gain that will be taxed at only 15%. It’s probably better to postpone the loss to 2013 when it can either offset a long-term gain taxed at a 20% rate or ordinary income that could be taxed at up to 39.6%.

Example 4: You show a net short-term loss of $3,000 in 2012. At year-end, you can sell stock at a short-term loss of $5,000. Best tax idea: Sell the stock. You can still use the first $3,000 loss to offset ordinary income in 2012. Then the $5,000 loss carried over to 2013 can offset short-term gain that may be taxed at 39.6%.   

Example 5: You are showing a net short-term gain of $5,000 in 2012. At year-end, you can sell stock at a long-term loss of $15,000. Best tax idea: Sell the stock. After you offset your gain, you can use $3,000 of the remaining $10,000 loss to offset income taxed at the 35% rate in 2012. Then you carry over the excess $7,000 loss to offset capital gains in 2013 and/or up to $3,000 of ordinary income taxed at the 39.6% rate in 2013.

Tip: Consider the long-term or short-term nature of any sales you’re contemplating late in the year.

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