As 2007 approaches year-end, you should look at your investment trading results so far. If you wind up 2007 with net capital gains you’ll owe tax when you file your 2007 tax return. In December, there is still time to turn that tax bill into tax savings.
First, check out Schedule D of your 2006 return. If you have a capital loss carryforward, don’t forget to include that amount in this year’s planning.
Next, find the results of all your trades so far this year to see if you have a net profit or loss. Say you calculate that you have $20,000 in net gains, all long-term, for 2007. If you have a $4,000 loss carryforward from last year, your net gain for 2007 will be reduced to $16,000, if you take neither gains nor losses the rest of the year.
With a $16,000 long-term gain, you’d owe $2,400 in federal income tax, assuming a 15 percent long-term capital gains rate. You may owe state tax, too. Therefore, you should check to see if you have unrealized losses in your portfolio and realize those losses by year-end.
If you can sell enough securities to realize $19,000 worth of losses, you will have a $3,000 net capital loss for the year: your $16,000 net gain will be offset and you’ll have a $3,000 in excess losses for the year.
A $3,000 capital loss is the most you can deduct from your other income. If you are in the 28 percent federal tax bracket, you’d save $840 in tax (28 percent times $3,000) instead of owing $2,400. Additional state tax savings also may result.
If you have additional net losses, beyond the $3,000 you can deduct, those nondeductible losses may be carried forward to future years, with no time limit. In the future, you’ll be able to use those losses to offset capital gains. Any still-unused losses may be deducted against your other income, at $3,000 per year.
When you do this year-end tax planning, don’t forget your mutual funds. Capital gains distributions are taxable income, whether or not they’re reinvested.
In the above example, if you also receive $2,000 worth of capital gains distributions from mutual funds, that will put your net gain for the year-to-date at $18,000, not $16,000. Therefore, you’d use $18,000 as your starting point to figure out how many losses you should take by year-end. If you take $21,000 worth of losses, you’d avoid paying tax on capital gains and have a $3,000 net capital loss to deduct.
