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With stocks, know when to hold and when to fold

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Are you holding stocks that have appreciated in value? You’ll likely owe a sizable tax if you cash in all your chips.

Strategy: Sell stocks after they qualify for long-term capital gain treatment. At the same time, hold onto stocks that would produce highly taxed short-term gains.

Once you trigger long-term gains, you can reinvest the proceeds in the same or similar stock if it suits your purposes.

The maximum tax rate for a long-term gain (i.e., on the sale of stock held longer than one year) is 15% or 20% for someone in the top 39.6% tax bracket. Even better, the maximum rate is 0% if you’re in the two lowest tax brackets (the 10% and 15% brackets). Conversely, short-term gains are taxed at ordinary income rates.

Example: You own Alpha Corp. stock acquired on July 1, 2014, for $10,000 that is now worth $18,000. In addition, you’re holding Beta Corp. stock that you bought years ago for $10,000 that is now worth $12,000. The outlook for both stocks is about the same. You figure you’ll be in the 33% tax bracket in 2015.

If you sell the Alpha stock, you’ll realize an $8,000 capital gain. However, the gain is a short-term gain, resulting in a tax bill of $2,640 (33% × $8,000).

Better approach: Sell the Beta stock now while holding the Alpha stock. Thus, your $2,000 gain is a long-term gain, taxed at 15% for a tax of only $300. Then you can wait until July 2 to sell the Alpha stock. Assuming the price stays the same, you only owe $1,200 in tax (15% of $8,000) on the second sale. Result: You’ve pocketed $2,000 more in stock sale profits this way ($10,000 – $8,000) while paying $840 less in tax ($2,640 – $300 – $1,500).    

Tip: Taxes aren’t the only investment consideration, but should be factored into decisions.

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