Tahoe-Truckee Market Beat: Year-end tax planning
November 29, 2016
With the stock market at record high levels, many investors may be considering selling stocks to lock in some profits or do some re-balancing. If your investments are held in a taxable account you should be aware of the tax implications of your decisions.
One is what's known as the "wash sale" rule. The wash sale rule states that you must wait at least 30 days to re-purchase a stock or "substantially identical" security if you have sold it for a loss or the loss will be disavowed.
So, if you have taken a loss in a stock, but still believe that it could be a good long term investment and wish to buy it back you have to let 30 days pass before buying it, or you won't be able to write off the loss.
It's important to understand the difference between the tax rates of long term and short term capital gains and losses. An investment is considered to be long term if it is held for more than 12 months and short term if held for less than 12 months.
Short term capital gains are taxed at your ordinary income rate, while long term capital gains are taxed at 20% if you're in the top income tax bracket, 0% if you're in the 10% or 15% income tax bracket and 15% for all other income tax rates.
If you have some short term losses they can offset your income, but long-term losses have an annual limit of $3,000 and the remainder, if you have losses greater than $3,000, will have to be carried forward to future tax years.
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There are three different methods for determining your cost basis. One is called FIFO — which stands for first in, first out — and is the assumption the IRS will make if you don't select a different methodology. If you use FIFO, you will sell the oldest lots first.
Another way is to calculate your average cost and use that number. The third way is to identify specific tax lots and sell the ones that give you the best tax advantage. If it's a year where your taxes are relatively low, you may want to sell the lots with the largest gain and if you want to minimize your taxes you could choose to sell lots with the smallest gain.
Our tax rules are complicated and seeking professional advice is always a good idea.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.