As the year winds down, you may not have enough investment income to deduct all your investment-interest expense.
Strategy: If you’re showing an overall capital loss, realize capital gains before Dec. 31. Not only will the gains offset capital losses — in effect, they’re tax-free up to the total amount of the loss — but you’ll give yourself more room to write off investment interest.
Here’s the whole story: To arrive at your net investment income, subtract your expenses (other than investment interest) from your investment income. For this purpose, “investment income” generally includes interest, short-term capital gains, annuities and royalties. It may also include qualified dividends and long-term capital gains if you choose, but that comes at a tax price.
The decision to include long-term capital gains as investment income or not doesn’t come until after you’ve netted your gains and losses for the year. So, you can still increase your capital gain by cashing in some stock winners.
If you’re already showing a gain this year, you might hold some losers until next year. That can preserve a bigger investment- interest deduction this year.
Of course, you might not want to keep stock that’s going downhill steadily, nor do you want to give up stock that’s gaining rapidly in value.
Here’s a better idea:
1. Sell the stock that’s declining in value.
2. Sell enough of the appreciating stock to offset capital losses as well as investment- interest expenses.
3. Buy back the appreciating stock right after you sell it.
True, you’ll buy the stock back at a higher price, but you’ll also increase your basis in the deal. That will reduce the tax bite on your gain when you sell the stock in the future. In the meantime, you’ll enjoy the write-off.