Wring tax savings out of capital loss carryovers — Business Management Daily: Free Reports on Human Resources, Employment Law, Office Management, Office Communication, Office Technology and Small Business Tax Business Management Daily

Wring tax savings out of capital loss carryovers

Get PDF file

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Suppose you’ve carried forward a short-term capital loss from securities sales in prior years. Now you’re poised to sell stock at a sizable long-term capital gain.

Strategy: Think twice. From a tax perspective, it doesn’t make sense to use a short-term loss to offset a long-term gain, which is taxed at more favorable rates than a short-term gain.

Unless circumstances dictate otherwise, postpone the sale or realize a short-term gain instead.

Here’s the whole story: Under longstanding rules, you can use capital losses to offset capital gains plus up to $3,000 of ordinary income ($1,500 if you used married filing separate status). Any excess is then carried forward to the next year. So a capital loss carryover is like having an ace up your sleeve.

Conversely, the maximum federal tax rate on long-term capital gain is 15% for most investors. For 2013 and thereafter, the American Taxpayer Relief Act (ATRA) increased the maximum tax rate to 20% for single filers with taxable income above $400,000 and joint filers above $450,000. But even with the ATRA change, the tax rates for long-term gains still beat the tax rates on ordinary income for upper-income investors. The top ordinary income tax rate in 2013, which includes short-term gains from securities sales, is 39.6%—almost twice as high.

Therefore, if you use a short-term loss carryover to offset a long-term gain, you’re effectively wasting your best tax punch.

Example: You have a short-term loss of $10,000 that you carried over from 2012. Now you’re sitting on a long-term stock gain of $15,000 and a short-term stock gain of $12,000. You expect to be in the regular 35% tax bracket in 2013.

If you sell the stock producing the long-term gain, the carryover loss will offset $10,000 of your long-term gain. The remaining $5,000 gain is taxed at 15% for a tax of $750 (15% of $5,000). When you sell the short-term gain stock in 2014, the tax will be $4,200 (35% of $12,000), assuming no other changes. Total tax: $4,950 ($750 + $4,200).

Better approach: Sell the stock showing the $12,000 short-term gain. The carryover loss still offsets $10,000 of gain, but now you pay tax of only $700 (35% of $2,000) on the net short-term gain. When you sell the long-term gain stock in 2014, the tax will be only $2,250 (15% of $15,000), assuming no other changes. Total tax: $2,950 ($700 + $2,250).

In other words, this strategy saves you $2,000 ($4,950 – $2,950).

Tip: Don’t let the “tax tail wag the dog,” but factor taxes into investment decisions.

Leave a Comment

Previous post:

Next post: